Stumbling Blocks in Maximizing Value

Despite the best intentions, many companies’ commodity-trading risk and pricing capabilities trail far behind their ambitious expansion plans.

The table below sets out the key challenges to maximizing value and offers strategies for overcoming them:

Extract optimal value from deal and portfolio
  • Focus is purely on risk compliance
  • Focus on risk-adjusted value capture and capital efficiency paired with best-practice governance
  • Employ a single methodological framework for deal valuation and risk quantification
Maintain optimal amount of capital, processes and mitigation measures to withstand market stresses
  • Only parametric and historical VaR used, rarely with adjustments for market illiquidity
  • Asset optionality is ignored
  • Use Monte Carlo simulation engine to incorporate empirical properties of commodities
  • Apply Earnings at Risk framework to reflect available market liquidity in close-out scenario
  • Incorporate physical characteristics of assets
Optimize capital, processes and mitigation measures to cope with counterparty
credit risk
  • Focus solely on current exposure and Credit VaR (if established) metrics computed on standalone basis
  • Only ad hoc requests for third party credit information with limited predictive power – often too late to mitigate against counterparty default
  • Develop life cycle perspective on counterparty credit risk and link to market scenarios allowing for an integrated counterparty valuation approach
  • Actively manage and trade credit risk at portfolio and deal level
Allocate risk capital with optimal efficiency
  • Risk is evaluated in silos with a limited amount of diversification considered between subportfolios
  • Lack of integrated view on market and credit risks
  • Overall risk contributions of each branch of trading activity are not captured
  • Quantify overall risk impact of a single deal and derive implications for valuation at the aggregated book, subportfolio and overall portfolio levels
  • Consider cross-commodity and inter-temporal diversification as well as individual book or framework risk contributions
  • Evaluate commonalities of risk drivers between market and credit risks
Establish liquidity and contract management sufficient to support growth strategies
  • Contract management solely focused on legal stipulations
  • Limited insight into mid to long-term liquidity needs
  • Adopt contract management with rigid governance around securities employed
  • Integrate working capital management as well as cash and net debt management with market and credit scenarios
  • Link different types of risk to increase the accuracy of liquidity planning
  • Support structured trade finance initiatives in illiquid assets

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