ERAC Audit Procedures & Risk Mitigation 4 — Questions and Answers
Question 1: An energy trading firm's audit shows that traders set their own position limits. This violates which fundamental risk control principle?
- Liquidity management
- Segregation of duties (Correct answer)
- Stress testing requirements
- Model validation standards
Correct answer: Segregation of duties
Segregation of duties requires that risk limit-setting be independent of trading functions; allowing traders to set their own limits eliminates a critical check on risk-taking behavior.
Question 2: Which method is used to validate that a VaR model accurately predicts losses over time?
- Stress testing
- Backtesting (Correct answer)
- Sensitivity analysis
- Scenario analysis
Correct answer: Backtesting
Backtesting compares a model's predicted VaR against actual observed losses to assess whether the model's predictions are accurate and statistically sound.
Question 3: During an audit of an electricity retailer, the auditor finds the company has no liquidity reserve policy. Why is this a critical gap in risk mitigation?
- It prevents the firm from expanding its customer base
- Margin calls and collateral demands during price spikes can quickly create a cash crisis without reserves (Correct answer)
- It violates NERC reliability standards
- It affects the firm's carbon reporting obligations
Correct answer: Margin calls and collateral demands during price spikes can quickly create a cash crisis without reserves
Without a liquidity reserve, unexpected margin calls triggered by sharp price movements can force distressed asset sales or default, making liquidity risk management essential.
Question 4: A midstream company transports gas for multiple shippers. What type of risk does the auditor focus on when evaluating exposure to shipper non-payment?
- Operational risk
- Regulatory risk
- Counterparty credit risk (Correct answer)
- Environmental risk
Correct answer: Counterparty credit risk
Counterparty credit risk is the exposure to financial loss if a shipper fails to fulfill their payment obligations under the transportation agreement.
Question 5: Which control best mitigates the risk of erroneous trade data entry in an energy trading system?
- End-of-day price feeds from exchanges
- Automated straight-through processing with pre-defined validation rules (Correct answer)
- Monthly external reconciliation
- Annual system penetration testing
Correct answer: Automated straight-through processing with pre-defined validation rules
Automated straight-through processing (STP) with validation rules catches data entry errors at the point of input before they propagate through downstream risk and accounting systems.
Question 6: An energy auditor reviewing a refinery's environmental risk program finds that spill response procedures have not been updated since a major regulatory change. This represents a failure in:
- Capital allocation methodology
- Regulatory change management and control update processes (Correct answer)
- Physical asset inspection frequency
- Insurance premium calculation
Correct answer: Regulatory change management and control update processes
Regulatory change management requires that internal procedures be reviewed and updated when relevant regulations change to maintain compliance and operational effectiveness.
Question 7: When assessing an energy company's enterprise risk management (ERM) framework, what is the auditor primarily evaluating?
- Quarterly earnings forecasts only
- The integration of risk identification, assessment, response, and monitoring across all business units (Correct answer)
- The accuracy of commodity price models
- The physical security of energy assets exclusively
Correct answer: The integration of risk identification, assessment, response, and monitoring across all business units
ERM framework evaluation focuses on how comprehensively and effectively the organization identifies, measures, responds to, and monitors risks across the entire enterprise.
ERAC Audit Procedures & Risk Mitigation 4
An energy trading firm's audit shows that traders set their own position limits.
This violates which fundamental risk control principle?