Risk Valuation, Management and Financial Governance Robert Young Deloitte & Touche NEM-NAESB Joint Industry Government Meeting July 22, 2002 Washington, DC

2 Overview Objectives Promote safety, soundness and stability in energy marketsPromote safety, soundness and stability in energy markets Raise investor confidence in energy markets participants through greater disclosure and assurance of adequate controlsRaise investor confidence in energy markets participants through greater disclosure and assurance of adequate controls Ensure awareness and accountability for off-balance sheet exposureEnsure awareness and accountability for off-balance sheet exposure Enhance competitive equality, and raise the overall level of risk competence industry-wideEnhance competitive equality, and raise the overall level of risk competence industry-wide Provide approaches to capital adequacy that are appropriately sensitive to the degree of risk involved in a firms positions and activitiesProvide approaches to capital adequacy that are appropriately sensitive to the degree of risk involved in a firms positions and activities Focus on risks of major energy markets firms, and yet also be suitable for institutions of various sophistication and complexityFocus on risks of major energy markets firms, and yet also be suitable for institutions of various sophistication and complexity

3 Building an Industry Framework Key Lessons Act Quickly and DecisivelyAct Quickly and Decisively Offer Significant and Sufficient ResponseOffer Significant and Sufficient Response Participation is Non-ExclusionaryParticipation is Non-Exclusionary Framework is Focused and RigorousFramework is Focused and Rigorous Approach is Taken SeriouslyApproach is Taken Seriously Scope is Appropriately DefinedScope is Appropriately Defined Senior Management InvolvedSenior Management Involved Commitment to ImplementCommitment to Implement Commitment to InvestCommitment to Invest Commitment to Manage by the Framework and its PrinciplesCommitment to Manage by the Framework and its Principles

4 Energy Market Stability Framework Risk Strawman Discussion draft presented by industry stakeholders under leadership of NEM Discussion draft presented by industry stakeholders under leadership of NEM Proposal for management of issues critical to energy market stability and restructuring Proposal for management of issues critical to energy market stability and restructuring High-level strategies to stabilize energy markets, promote industry accountability and realign performance values High-level strategies to stabilize energy markets, promote industry accountability and realign performance values Designs for transparency of energy market information and participant performance Designs for transparency of energy market information and participant performance Calls for broad-based comment, collaborative development, on-going discussion and support Calls for broad-based comment, collaborative development, on-going discussion and support

5 Energy Market Stability Framework Key Principles Disclosure Disclosure Market Risk Market Risk Credit Risk Credit Risk Capital Adequacy Capital Adequacy Governance Governance Compliance ComplianceConstituents Energy Energy Banking and Investment Firms Banking and Investment Firms Regulatory AgenciesRegulatory Agencies Federal: CFTC, SEC, FERC, FASFederal: CFTC, SEC, FERC, FAS State: PUC & PSC, etc.State: PUC & PSC, etc. Ratings AgenciesRatings Agencies Standards GroupsStandards Groups NAESB, EEI, ESPA, GAAPNAESB, EEI, ESPA, GAAP

6 Energy Market Stability Framework Risk Framework Topics Disclosure - Qualitative and Quantitative informationDisclosure - Qualitative and Quantitative information Define: Risk Exposures - Risk Management - Earnings Define: Risk Exposures - Risk Management - Earnings Clear understanding and communication of business activities that create risk and impact returnClear understanding and communication of business activities that create risk and impact return Market RiskMarket Risk Standardized portfolio valuation and mark-to-market methodsStandardized portfolio valuation and mark-to-market methods Standard metrics: Value-at-Risk (VaR), RAROC, SVA, Peer AssessmentStandard metrics: Value-at-Risk (VaR), RAROC, SVA, Peer Assessment Credit RiskCredit Risk Multi-lateral clearing and settlement – physicals and financialsMulti-lateral clearing and settlement – physicals and financials Standard metrics: current and potential exposure, default probability, quantification of riskStandard metrics: current and potential exposure, default probability, quantification of risk

7 Energy Market Stability Framework Risk Framework Topics Capital Adequacy – new quantitative measuresCapital Adequacy – new quantitative measures Link Risks with Capital required to manage themLink Risks with Capital required to manage them Demonstrate new levels of financial stability within entities and across industry by strengthening measures of capital adequacyDemonstrate new levels of financial stability within entities and across industry by strengthening measures of capital adequacy GovernanceGovernance Code of Conduct: activities, behavior and ethicsCode of Conduct: activities, behavior and ethics Accounting standardsAccounting standards Risk oversightRisk oversight ComplianceCompliance Establish degrees of formality for compliance with restructured Risk Management StandardsEstablish degrees of formality for compliance with restructured Risk Management Standards Structured Attestation; Internal and Independent AuditsStructured Attestation; Internal and Independent Audits

8 Unified Energy Industry Taskforce Energy Banking Rating Agencies Standards Groups Regulatory Agencies Risk Valuation and Metrics Price Transparency Levels of Disclosure Capital Adequacy Compliance Leverage work and competencies of existing effortsLeverage work and competencies of existing efforts Develop proposals with teams of stakeholder representativesDevelop proposals with teams of stakeholder representatives Task Force