Without a doubt, companies have had to change how they view risk over the course of the financial meltdown. Risks that were either ignored or considered a low priority have now risen to the top of their lists of musts-to-avoid.
At Constellation Energy Group, which had a cash scare last year, liquidity risk is now one of the top issues on chief risk officer Brenda Boultwood’s watch list. The company’s stress tests for determining its cash needs did not prepare it for the “extreme” rise in commodity prices of 2008, Boultwood says. To compensate, in late August, Constellation decided to divest its upstream gas assets and sell other parts of its business to create more cash flexibility.
However, those plans weren’t enough. For one hair-raising week in mid-September, Constellation was in crisis mode and its stock price in free fall following the collapse of Lehman Brothers, which was one of its trading partners. At first, Constellation tried to assure investors that the Lehman failure wouldn’t have a material effect on the company and that it had access to a $2 billion credit facility. But by the end the week, Constellation had agreed to be bought for $4.7 billion by MidAmerican Energy Holdings, a Berkshire Hathaway company, which pledged to make an up-front, $1 billion cash investment in Constellation. The deal later fell apart after Electricite de France (EDF) offered to buy nearly half of Constellation’s nuclear subsidiary for $4.5 billion.
Months later, says Boultwood, who will talk about risk management at the CFO Core Concerns Conference in Boston on June 15–17, Constellation took several actions to reduce its liquidity risk to avoid a repeat of last year’s scramble. For example, the company freed up $1 billion in capital by divesting its coal and freight business, as well as its wholesale natural-gas business. That collateral had been posted, under regulatory requirements, in case of rising commodity prices.
“We’ve lived through a five-year period when credit for all companies was very much available and inexpensive, and now all companies have to adjust to that change,” says Boultwood.
The company also implemented new models for measuring risk. For instance, Constellation has introduced more sophisticated probabilistic and scenario-based stress tests of the company’s liquidity requirements over a rolling two-year time horizon, according to the risk chief.
Indeed, Boultwood’s partial list of her top risks right now — she declined to list all of Constellation’s biggest exposures — reflect the heavy responsibilities CROs face as they shift their company’s approach to risk management in the current economic environment. Among her top worries: the recession, which could affect the solvency of Constellation’s counterparties, and the pending transaction with EDF.
One of Boultwood’s duties right now is keeping the company’s board of directors updated on how her team is mitigating the risk that EDF will delay or back out of its investment promise. “If we don’t close that transaction, the biggest issue for Constellation is potentially our reputation,” she explains. “It will indicate that something Constellation said we were going to do for whatever reason did not get done.”