Examiner Guidance

As emphasized in this product summary, the major risks of an energy portfolio are basis risk, volatility risk and — in certain cases — liquidity risk. Banks whose customers are seeking to hedge basis risk between an out of location (other than NYMEX) delivery point and the NYMEX delivery point, could be exposed to substantial basis risk if the bank's side is not perfectly offset with another transaction. Volatility tends to be quite a bit higher in energy products than it is in many of the popular financial products (eg, government bonds and currencies). Higher volatil­ity means higher risk for like exposure. Thus, ongoing scrutiny to the many factors which influence energy prices would be an expected characteristic for a trading group which accepts exposure to those factors. Hedging strategies which implement a "stack and roll" process should demonstrate an appreciation for the enhanced exposure to curve risk which such a strategy introduces. The following specific questions, when used in conjunction with guidance provided in the Federal Reserve's Trading Activities Manual, will help examiners to assess the specific market risks which may be present in a bank's energy portfolio:

1) What percentage is your energy book relative to your total trading portfolio?

2) How much overnight risk are you able to assume in the portfolio?

3) Are any of your energy swaps indexed to a pipeline other than NYMEX delivery points? If so, are those hedged
to the NYMEX or hedged to the specific pipeline?

4) To what other pipelines are you willing to take exposure (trade swaps)?

5) Do you make markets in basis swaps (ie, NYMEX vs. some other location)? If so, how liquid is the market for
that basis? How many players are in that market?

6) Do you ever employ a stack and roll hedging strategy? What are your guidelines for rolling the hedge?

7) How would your book perform if the energy term structure inverted tomorrow? Do you simulate this exposure
on a regular basis?

8) How do you stress test your energy book? Do you shock spot prices, curve shape, or any elements of carry?
What are the assumptions underlying the shocks? How frequently do you revisit the insight behind the assumptions?

9) How (if at all) does the risk management methodology differ from that used for non-energy books?