Trading&RiskManagement
Trading Technology
Tokeepupwithtoday’scommoditiesmarkettrendsforgrowthandsophistication,
commodity traders need to focus on their operational practices to achieve high
performance.Firmsthatlackthecapabilityforstraight-through-processingfortheir
commoditiesderivativesareexposedtooperationalrisksresultingfrominadequate
automationandcontrols.Usingnewtechnologytoautomatekeyaspectsofthetrade
life-cycleoftheseinstrumentsisimperativeinthefollowingareas:
• Integrated&scalableinfrastructureformulti-assetcommoditiesprocessing.
• Flexibleworkflowmanagementtosupportcomplexbusinesslogic.
more typical ETRM space. “For the
• Superiorreal-timeconnectivitytoelectronicmatchingandconfirmationservices.
vendor, that’s a conundrum and for
• Real-timereporting&controlsatanyleveloftradedetail.
the prospective user, it can be
• Buy-sidesolutionadoptiontoensureSTPacrossallcounterparties.
downright confusing,” according to
GaryVaseyofUtilipoint(seepage70).
fewyearsago,it’sdifficulttotradejustasinglecommodity.
Multi-commoditytrading–notjustinenergybutacrossall Adopting Best Practices
commodities–isincreasinglythenorm. 1. Set a realistic hedging objective
A second significant change is that simple directional considering market realities
tradingstrategiesthatprofitedearlierinthecommoditiescycle It is common practice among corporations to form price
areincreasinglybeingreplacedbymoresophisticatedtrading viewsbyreadingreportsandtalkingtosuppliersandhedging
strategies including spreads, options and even ‘black box’ counterparties.Hedgingobjectivesaresetonceayearpriorto
trading. Some trading strategies conducted by financial the beginning of the financial year. It is important to set
players in these markets would not make much sense to objectivesconsideringmarketrealities.
traditionalphysicalenergytraders.Whatoftengetsforgotten 2. Set strategies to reflect hedging objective
isthathedgefundsandinvestmentbanksmakemoneyin and review them periodically
bothupandownmarketsand(asdiscussedabove)arenot Thehedgingobjectivemustcoversomekeyquestionslikehow
limitedtoafundamentalviewofthecommodityworld,seeing muchtohedge,wheretohedge,whatinstrumentstouse,etc.
opportunities that play across different asset classes. 3. Execute only structures where payoffs can be
Furthermore,thereareawidervarietyofinstrumentstotrade. understood and which can be priced and valued
The final change worthy of note is that with these new Thisensuresthatderivativestradesareexecutedforhedging
instruments, trading strategies, factors influencing price and that their payoffs offset the market risk due to your
formationandchangingcommodityinter-relationships,there natural exposures. Ability to value the structures
isanimpactonriskmanagement.Firstly,asvolatilitiesand independently enables the corporation to understand the
otherparametershavechanged,tradersshouldaskthemselves marketvalueoftheirhedgesatanypointintimesothatthey
thequestion,“Aretheriskmeasuresbeingusedstillreliable?” canmakeactivehedgingdecision.Ensurethattheabilityto
Many quantitative statistical measures assume that certain valueexoticstructuresexistsin-housepriortoexecution.
factorsarewithincertainbounds(volatilityforexample).If 4. Understand the risks completely
thisisnolongerthecasethentheriskmeasuresbeingused Develop the ability to understand the risks, rewards and
nowmightbeinappropriate.Ashistoricaltrendsbreakdown, sensitivitiesofthederivativesstructuresusedforhedging.This
itcanalsobearguedthatriskmeasuresrelyingonhistorical wouldhelpindynamicallymanagingthehedges.
data and market behaviour are now also increasingly 5. Understand how the structure performs in different
inappropriate.Nowisthetimetoreviewyourriskmeasures market conditions and in case of events
and statistics and to move to models that rely more on Sinceitisdifficulttopredictevents,itisimportanttohave
stochastic variables. Now is also the time to conduct more theabilitytounderstandhowthederivativestructuresbehave
rigorousstresstestingofyourportfolio. whenthereareextremepricemovements.Thisabilitycould
Whilethisisjustasummaryofsomechangesthathave furtherhelpinpre-tradeanalysis–evenbeforethederivative
takenplaceinenergyandcommoditytradingasaresultofthe structure has been traded, so that only structures with
changesobservedinmarketsinthelastfewyears,itisnot,and acceptableeventscenariosareactuallytraded.
cannotbecomprehensiveinthecontextofthisarticle.What 6.Establish a process around risk management
shouldbeapparenthoweveristhatasmarketshavechanged Arobustprocesshelpsestablishbestpracticesrightfromthe
–andwiththemthenatureoftrading,tradersandrisk. pointofdecidingtheobjectivethroughthestepsofformulating
Theissueremainsthatcommoditytrading,transactionand astrategy,executionofhedges,monitoringthosehedgesand
risk management is a complex area with widely varying settlements. The process must also address and mitigate
requirementsthatthisarticlehasonlyscratchedthesurface operational risks which could otherwise undo the benefits
with. While the big trend right now is to move toward expectedfromhedging.
•
commoditytradingandriskmanagementsoftware,therewill
alwaysberoomformorespecialistsoftwareprovidersinthe
Guy IsherwoodisPublisherandEditorofWorldPower.
www.commodities-now.com
worldPower2009 37
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