Case Study
Company A
Company A is an unregulated electricity wholesaling firm
owned by a utility holding company.
Current Organization
The company is small, with just 35 employees.
Day-to-day operations are run by a president, but strategic decisions
tend to be made by a vice president of the holding company. The risk
management department reports to the controller of the holding company
and comprises two people. The board of directors is composed of
executives from the holding company and Company A. There is a Risk
Committee that comprises the board members and the two risk managers.
It also includes a lawyer and an operations VP, both from the holding
company.
Soon after it was formed, the company hired a
number of professional traders and engaged in modest speculative
trading and “back-to-back” wholesale transactions. Results from the
speculative trading were poor, and the Risk Committee severely limited
subsequent trading activities. This left traders with little to do,
and all but one soon left the company. Today, the entire (speculative)
trading department comprises that one trader.
A modest wholesale business continues. The focus
is on plain vanilla "load serving" deals. The firm is
actively seeking to take over public utilities’ wholesale clients. The approach
is extremely conservative.
The firm was “forced” to get into the retail
electricity business by the holding company. To date, this has been a “loss
leader” with a risk manager commenting: “We sell electricity at a loss, but maybe we are learning some
lessons from it.”
There is a Power Marketing group that engages in
short-term transactions of under a week. The firm has no generating
facilities, but has not ruled out ultimately purchasing some.
The board of directors is actively engaged in the
operation of the firm and are very conservative about risk. They
perceive a need to identify the right niche for the firm in the
deregulated marketplace but don’t want to “invest another 10
million dollars just to see it lost.” Accordingly, the company faces
significant business risk as it plans a strategy for the future, but
it is loath to take any tactical risks that could lose money in the
short-term. Junior and middle-level staff complain that they can’t do
anything because controls and risk limits are so prohibitive.
There is a monthly Risk Committee meeting
immediately following the monthly board meeting. This is largely a
continuation of the board meeting with a few additional attendees.
The Risk Committee “reviews” new policies and procedures just
implemented by the board. They also review all credit risk and market
risk limit violations during the month. “They pounce on any
violations.” They also review volume of activity in each of the
businesses and may occasionally have educational presentations
relating to aspects of risk management. Recently, the risk managers
were going to give a presentation on value-at-risk (VaR) but were
cautioned: “You can explain VAR to us, but don’t get too technical.”
In addition to the two members of the risk
management department, the firm hired a dedicated risk manager to work
in the wholesale department. This individual was to provide second
opinions on trades prior to their being made. That individual has
since taken on wholesale trading responsibilities.
The risk management department itself is
responsible for supporting the board’s policy and procedure setting.
Policies and procedures were originally written by a consulting firm
but don’t fit the business. Accordingly, the risk managers constantly
draft consent resolutions to have them updated. Continually rewriting
the policies and procedures manuals to reflect these changes is an
enormous task. Risk managers enter all trade tickets and perform other
related tasks. They monitor activities of other departments to ensure
policies and procedures are being observed. Other work includes
preparing risk assessments for the board on all proposed wholesale
transactions and preparing a comprehensive risk report each day. A
frustrated risk manager commented: “It is amazing how you can prepare a
daily report for 35 people and have them understand so little of it.”
The original utility (which became the holding
company) was a very paternalistic
company. It had a “family culture.” That is going away, especially in
Company A. People feel threatened and isolated. As a means of gaining
job security, they hoard information, refusing to share it with
others.
Decision making is confrontational. “You can’t do
a deal until it is analyzed every way.” Wholesale traders undermine
the role of the risk managers by withholding information on proposed
deals until it is too late to perform analyses. Five times, the
president has called the risk managers into his office and threatened
to fire them: “You are bright people, but you just don’t do your
jobs.”
Risk managers do not feel that they are allowed
to be facilitators and feel “unpopular” for this reason. They are,
however, proud of their work, and point to their successes in credit
risk management. The firm has survived two volatile summers without a
single credit loss. Last Summer, the board actually set aside $100
million in anticipation of credit losses that never came.
Questions
Company A
1.
On a scale of 1 (poor) to 10 (excellent), how well would you say
senior management understands the risks being taken by the firm?
Explain your answer.
2.
On a scale of 1 (poor) to 10 (excellent), how well would you say has
senior management communicated a clear purpose for tactical risk
agents? Explain your answer.
3.
Is there a clear distinction between risk management and other
functions?
4.
In the following table, select the cell that best describes risk
management (its strength as well as its effectiveness) in the company.
Base your assessment on the following definitions:
·
Risk management is strong if it exists in
practice as well as in name, has a clearly defined role and has strong
support throughout the organization.
·
Risk management has a positive effect if it
promotes a sound risk taking process that would not exist in its
absence. A negative effect detracts from the organization’s risk
taking process.
5. Explain your answer to the last question.
6. How would you improve this company’s risk
management?
Recent Developments
Company A
There was another incident recently that landed
the risk managers in the president’s office. There was shouting, desk
slamming and their jobs were threatened again. They have a modicum of
job security because they report to the controller of the holding
company. However, the president is now lobbying to have risk
management report to him. This is being opposed at various levels of
the organization. If the change were to take place, the organizational
chart would be as shown below:
Proposed Organization
Follow-up Questions
Company A
1.
What is good or bad about this development?
2. Does this development reinforce or counter your earlier
conclusions about the company?
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