Hedge Funds from an Energy Risk Management Software (ERMS) perspective
By Claudine Trottman and Ilker Kurt
Hedge funds emerged as a new class of financial actors in the energy trading complex during a period where the effects of the energy merchant industry collapse started to fade away and the poor performance of global equity markets forced investors to search for alternative investment opportunities. By definition a hedge fund is an unregulated private investment institution that seeks high returns from unconventional opportunities via alternative investment strategies. Therefore, it didn't take too long before the high volatility environment of the energy markets attracted many high profit seeking hedge funds, whose typical investor had a risk appetite is considerably higher than the average.
Hedge funds first entered into the energy space by taking positions in exchange traded instruments where price transparency is higher and counterparty exposure is absorbed by the clearinghouse. From this, hedge funds began to explore and expand into the more risky physical markets. Therefore, their ERMS requirements transformed quite significantly in order to capture/manage the inherent risks of the markets they participated in.
Even though energy hedge funds share similar trading business models with the rest of the energy market players, their ERMS needs and system utilization may differ in many ways from a typical E&P company or utility. BookRunner®, an already established multi-commodity, fast implementation solution for the traditional energy sector, provides a reliable energy solution to this new segment of energy market.
Let's have a closer look at a typical energy hedge fund's daily process with BookRunner®.
As with many other energy trading complexes, the typical trading process in an energy hedge fund commences with transaction capture and curve updates within the BookRunner® application. Throughout the day, traders track/manage their outstanding positions via real-time position management' reports which are produced by customized BookRunner® database queries.
Following the markets close, all transactions entered into BookRunner® are reviewed, verified and approved by reconciling the trader reports with the BookRunner® Transaction List report. Upon completion of the trade verification routine, BookRunner®'s Mark-to-Market process is executed in order to update the portfolio of all locked trades with the most current prices, revalue options, create and update settlements. Subsequently, BookRunner® MtM report is executed to verify that all prices have been updated successfully and the MtM numbers match the traders' expectations.
The volatility and correlation matrices are also created/modified daily and uploaded into BookRunner® during this end of day process. Matrix maintenance, an essential part of Value at Risk reporting, has been made very easy and user-friendly with BookRunner®'s integration to FEA's MakeVC application. Following the upload of the matrices and creation of VaR statistics by using either BookRunner® or a third party engine, a high level daily summary report which includes daily P&L and VaR changes is forwarded to all interested investors and senior management.
Hedge funds typically utilize Fund Administration companies as part of their active transaction verification procedure. A Fund Administration company ensures that trades are entered correctly into the risk management system and that the customized reports using the BookRunner® database extract the current day's trades for reconciliation with the respective counterparties, power pools and other sources. BookRunner®'s collateral management module also provides assistance to the Credit Manager in identifying/managing margin requirements with the fund's counterparties during this reconciliation.
BookRunner® provides extensive transaction capture of energy commodities, including hourly granularity for Electricity transactions. In addition, MTM, P&L VaR, and Investor reporting along with a variety of standard reports allow for dissemination of information to all parties involved. Risk management policy compliance capabilities including confirmations, audit reports, Credit, Collateral Management, and Settlement modules provide a robust environment for Hedge Funds to operate effectively in. The flexibility to interface capacity with third party tools such as FEA @Energy and FEA MakeVC, makes BookRunner® a an integral part of the rapidly expanding hedge fund industry.