Ongoing effects of the Russian war against Ukraine and sanctions against specific companies have a direct impact on credit risk, especially for companies trading in commodities such as electricity and gas. In fact, sanctions against companies lead to a situation comparable to a default of the corresponding counterparty in operational risk management. Nevertheless, there are still ongoing contracts with these companies regarding the supply or purchase of commodities or energy.
The situation described may lead to the point at which a termination of ongoing ISDA or EFET agreements, could be considered for example. Basically, the following options are available for the usual EFET and ISDA master agreements, which require a legal case-by-case examination:
Contractual arrangements (EFET & ISDA master agreements)
ISDA1's general master agreements and EFET2 master agreements do not explicitly address the consequences of sanctions. However, ISDA has already published a white paper3 on this subject in 2019, which provides recommendations on how to include specific provisions on sanctions issues in contracts.
In contrast, EFET agreements already include in their general regulations that early termination of the agreement is possible for "good cause". The legal department should be consulted whether sanctions or the consequences of sanctions fall under “good cause”. These reasons are specified, for example, in the EFET2 paragraph 10, section 5. The EFET master agreement also stipulates that if the operation of a gas pipeline system is compromised by force majeure (for example, so-called transmission failure), no breach of contract exists. Once again, the question is whether sanctions in this context could fall under force majeure (EFET2, paragraph 8).
Further measures in risk management
Apart from the fundamental question of whether existing contracts must/should be terminated due to imposed sanctions, it is strongly recommended to shorten the frequency of reviewing the solvency risk of high-risk contractual partners. Crises often develop in a highly dynamic manner, with the respective governmental and international institutions taking decisions on short notice. It is therefore essential that in these times, risk management identifies all potentially risky contractual parties and coordinates immediate options for action with the Executive Board for various scenarios. Saying: “It wasn't raining when Noah built the ark”. It is also necessary to monitor credit risk, possibly even on a daily basis, for high-risk contractual partners and to check whether future contracts with high-risk companies require advance payment agreements or other collateral.
Furthermore, it is advisable for energy suppliers to economically calculate the risk from procurement and sales for an unplanned addition of new customers, should a larger number of customers have to be taken over into an energy supplier’s basic supply due to insolvencies.
Source: KPMG Corporate Treasury News, Edition 119, March 2022
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Mangement, KPMG AG
Edmund Menge, Senior Manager, Finance and Treasury Mangement, KPMG AG