Holistic Risk Management Requires Robust Technology
capabilities to achieve better performance. For example, firms that lack the capacity for straight-through-processing for managing energy derivatives are exposed to operational risks resulting from inadequate automation and controls. Using new technology to automate key aspects of the trade life-cycle of commodities is therefore imperative in the following areas:
T
• Integrated & scalable infrastructure for multi-asset commodities processing.
• Flexible workflow management to support complex business logic.
• Superior real-time connectivity to electronic matching and confirmation services.
• Real-time reporting & controls at any level of trade detail.
• Buy-side solution adoption to ensure STP across all counterparties.
Unlike many other software categories, energy and commodity trading and risk management (ETRM/CTRM) software has remained a bastion of the traditional licensing, implementation on-site, and support and maintenance model. The reason for this lies in the sheer complexity of the requirements for the software. “Commodity trading, transaction and risk management, as a practice, is complex – very complex – and for a variety of reasons. Traders in this industry can (and many do) transact in multiple commodities, multiple markets, multiple instruments, multiple assets, multiple currencies, and utilise multiple transportation methods. They make their buying and selling decisions by constantly tracking and analysing price trends, price correlations, supply/demand imbalances, physical system constraints, weather forecasts, and a plethora of other factors, both internal and external to the company,” explains Dr. Gary Vasey of CommodityPoint. Even the most ‘simple’ commodity trading activities (such
as buying/selling a single commodity in a specific market or region) usually involves complex deal structures and specific, highly detailed logistical requirements. As a result of all of this complexity,
o keep up with today’s energy market trends for growth and sophistication, traders and managers need to focus on both operational practices and technological
a traditional commercial software market at all. “Any software package in this space, at best, may meet 80% of the requirements after configuration (and more commonly less than 70%) with the remaining requirements being met via other packages, home grown software, the ubiquitous Excel spreadsheets or manual process,” says Vasey. “That’s why integration is such a pervasive (and often massive) issue for the trading and risk departments of almost every trading firm on the planet. The successful larger ETRM/CTRM vendors have found
ways to develop broadly functional software that is highly configurable, usually using a modular approach to deliver specific functionality for specific areas such as a particular commodity, market, geography or function. Their success in developing these modular solutions is evidenced by at least two vendors boasting of greater than US$100m annual revenues and several more are between US$30m and US$100m. But there are more than 80 vendors with multiple products still serving this marketplace, with many of those serving a small geographic or functional niche – and doing so profitably.
Managing Risks The financial crisis exposed a cloud around derivative
the systems that are used to capture, track, analyse and account for trading activities – the T&RM software systems – tend to be built to be highly configurable. They have to be built that way or else a commercially packaged software model couldn’t work in this space, as the size of this software market will never be large enough to justify the investment in developing a true ‘one size fits all’ shrink-wrapped software solution. In fact, the ETRM/CTRM software market simply isn’t
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Recent market volatility has created a growing demand for T&RM systems
structures and the profit and loss implications of using exotic instruments and structures. However, this lack of understanding was not limited to the financial sector. While banks and other financial institutions made a thriving business out of structured products there was a lack of transparency about the models and data used for the pricing and valuation of such instruments. Over time, derivatives became more and more exotic, designed to suit the risk appetite of a more diverse band of customers. Many of these institutions have clearly used structures wholly inappropriate to their operations. Corporations and utilities, whose original risk management function was to hedge their commodity market risk, now face the ever increasing challenge of selecting the right structures to hedge, both price and value, as well as manage the risks once they execute hedges. Hedging is, of course, a conscious decision. Corporations that consume or produce commodities have a need to recognise and manage their exposure to price risk due to changes in commodity input and output prices. This is
particularly important as volatility has increased. It is equally true in ‘normal’ times as the mean-reverting commodity markets are one of the world’s most volatile asset classes. For holders of assets, the objective of hedging is to secure a certain price level for the commodity consumed or produced and/or avoid catastrophic losses in the event of markets moving in the ‘wrong’ direction. Most often, the need to secure price levels arises due to
worldPower 2010
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