Defining the Needs of a Trading Organization
By Steve McMane, Trader, Crude Oil and Refined Products, Suncor Energy Inc.
Most of the risk management systems in the marketplace have been built with middle office functionality in mind, forgetting that the front office traders are also a key component in the overall risk picture. Without the trading function, revenue optimization would not be possible, nor would the need for the latest more dynamic middle office functionality that software companies are offering. I am generalizing somewhat, but most traders tend to be light years behind the technology curve; relying largely on legacy Excel models to capture details like mark-to-market, positions, and VaR. Traders usually “make do with what they have” and rely on the middle office to track vital information. This article explains how a dynamic Energy Risk Management (ETRM) system can foster a more profitable working relationship.
What the ETRM space needs is a more dynamic front office system coupled with middle office functionality to better leverage both groups' expertise. Efficiency is the key when designing a system for trading. Trading decisions are real time but information tends to be disseminated long after the market has closed. Real time position updates in both the hands of front office and middle office in real time would improve decision making, and provide better clarity of a trader's risk positions.
Price management is also a particular constraint to the entire trade group, as many companies struggle to provide good pricing. Front office manages price risk daily, and price risk affects all aspects of the trading business. One example is options trading with sophisticated financial derivatives found in their portfolios. The underlying positions of these books have significant exposure derived strictly from price movements.
Here is another example. Physical players may be long assets with inherent optionality, such as a lease on natural gas storage; this position has optionality embedded in the exposure. Without proper models, effective and profitable optimization may not be achieved consistently. Middle office groups struggle for clarity also, as they only get to see trader positions “after the fact” once the market has settled rather than having an understanding of strategies as they take shape. This makes it impossible for risk managers to be more proactive in their work, as lack of real time information forces them to be reactionary which can foster discontent for all parties involved.
Vendors in the ETRM space would be well served to find a way to link prices to underlying exposures on a real-time basis to provide as near as possible up to the minute quantification for better decision making. “At Risk” and multi-variable stress testing measures that can be easily calculated on a near real time basis on an up-to-date positions table can also give traders a better picture of the potential risks inherent in a deal they may wish to undertake. None of this is new really; what is new is the technology to be able to provide this type of information in a real time space.
Computing horse power has been focused on the transaction execution, electronic exchanges, deal capture, and broker statements to better help traders. Now is the time for the ETRM space to combine the expertise of the front and middle office people in an organization to increase the clarity and communication, and subsequently reduce unnecessary risks, in a very risky endeavor.