VALUING & MEASURING RISK
etc. Because of their availability, these same analysts are then selected to ‘build the risk application’. However, this approach can come with severe limitations. Firstly, when a quantitative analyst is asked or (on many occasions) ‘volunteers’, to build a risk application there is an unfair expectation that the analyst is a ‘master of all trades’. To build a successful energy risk and valuation application requires a diverse range of skill-sets. These include specialist knowledge on pricing assets and valuation algorithms, theoretical knowledge on stochastic processes, financial engineering skills, database management skills, and user interface programming. It is almost impossible for these skill sets to be mastered by one individual, or, apart from the largest energy companies, even available within one organisation. As the responsibility for projects of this kind tends to be allocated to just one or two key individuals, such a scenario can seriously hinder the successful completion of the application development. Secondly, there is often a perception that internally developed applications are a far less costly option than deploying an external software solution. The reality is that the costs associated with undertaking a project to build a comprehensive risk and valuation engine internally are not well understood by management, and often severely underestimated. These range from the initial specification of an application needed to meet the needs of trading, risk management, valuation, structuring and origination groups, who have a diverse range of functional requirements for risk and valuation analysis and reporting, to the longer-term costs involved in keeping the analytics model libraries up-to-date. It is not unusual to hear of even small applications needing 1 or 2 full time analysts to keep them running. Thirdly, there is also often a perception – in fact it’s probably the
of inclination to do so). Once these key individuals leave, they essentially take the intellectual property with them and their replacements are left with little or no record of the algorithms, models and methodologies on which internal solutions are based and are stuck with inflexible internal applications that do not meet current or future requirements.
Robust Third-Party
Risk Applications In the last few years we have seen
the emergence of a third approach – robust third party applications which are designed and are purely focussed on meeting the portfolio wide risk measurement and reporting requirements of typical energy companies that address both physical
... there are systems available now that address the special needs of the energy and commodities industries
main justification for in-house development – that by internally developing risk and valuation applications, intellectual property is retained within the organisation and models are built to bespoke requirements. In reality, internal build projects of this kind are led by just one or two individuals with specialist knowledge. As a consequence, the scope of functionalities for risk and valuation tends to have a narrow focus and are not usable for other groups in the organisation. Then there is the question of what will happen when these key individuals leave the firm. A lack of adequate documentation and knowledge transfer amongst team members is a prevalent problem in trading organisations, due largely to the time and effort involved for a few key people in putting this type of information together (as is often their lack
assets and financial contracts. Complex valuations; metrics that provide meaningful indicators of business health; robust systems that stand up to the external scrutiny of credit agencies, regulators and shareholder demands and systems that are flexible enough to cater to the unique demands of an individual business. Many players are becoming aware
that it need no longer be a wish list – there are systems available now that address the special needs of the energy and commodity industries; systems that can leverage the in-house strength of model (as opposed to application) development. No lead time and no need to replace
existing CTRM systems. •
Dr. Chris Strickland is a Director of Lacima, a specialist provider of software and advisory services dedicated to valuation, optimisation and risk management for global energy and commodity markets. Lacima helps companies maximise
their profit potential and make more informed decisions by providing tools that yield more accurate valuations, hedging analysis and risk exposure analysis for portfolios of financial contracts and physical assets.
E:
chris@lacimagroup.com www.lacimagroup.com
June 2012 43
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