Can metals traders gain an edge in the changing risk management landscape?

Before the global Covid-19 crisis, analysts had been predicting a continuation of the slump in commodity trading margins, which as this 2019 article points out, had already fallen 20% since their 2015 peak. Metals traders have been aware of these reducing margins and exploring solutions to improve profitability for some time, although the disruption of recent months has created more urgency to protect both profitability and the business from a growing range of risks.

The coronavirus has obviously had a significant impact on global health, everyday life and the commodity markets that supply so many essential products and rely on so many skilled professionals. Along with introducing major market disruption that has affected each metal differently, the coronavirus has exacerbated many risk factors, including credit, counterparty, liquidity and operational and supply chain risk. The threat to business is real, with one panellist at the recent Commodity Trading Week Online predicting we will see companies without a risk manager disappear. Although these risks represent a threat to all metals traders, they do also mean there are opportunities that those with the best risk management processes are best-placed to capitalise on.

Risks metals traders are facing

Credit and counterparty risks are closely linked in the current environment. Just as traders are managing their counterparty risk by imposing stricter controls and working with their most creditworthy partners to reduce the risk of default, banks are tightening their own risk controls and restricting credit to partners that are demonstrating adequate risk management.

This means that traders with the systems and controls in place to show external stakeholders they are actively managing counterparty risk are also more able to access credit; one of the factors facilitating more profitable trading. This credit is not only a key factor in profitable trading, but essential for hedging, with its associated risk management and opportunity to create further profitability.

Liquidity risk

Many larger players have increased their short-term liquidity position, some traders are having problems finding the liquidity to financially hedge safely and questions are being raised about whether less capitalised entities will retain market access. Those organisations paying attention to their own liquidity risk are only managing a proportion of the actual risk if they are not applying and regularly reviewing effective Know Your Counterparty (KYC) policies, as they are also exposed to the risk of counterparties suffering from a lack of liquidity.

Managing these risks accurately and in real-time does not only protect the business from the risk itself. Supplying real-time risk and position data to those who need it can also have a significant impact on hedging; making more dynamic hedging possible as markets move with greater volatility – both to manage the volatility and to take a profit on hedges as they move. This allows for more creative, active strategies and increased opportunity – whilst controlling the strategies’ risks.

Operational risk is key

Working remotely has introduced a raft of new operational risks even to organisations that were ahead of the competition in other areas of risk management. Although the industry has on the whole adapted quickly to remote ways of working, it has raised challenges for most organisations, and in our experience, particularly within Operations who rely on contact with other team members.

Even amongst traders who do use CTRM or other software to manage operations, there are often still some processes that occur offline, and with teams working away from centralised offices these become even more fragmented. Spreadsheets and other offline documents have always carried a risk of local copies being out of date, data being copied incorrectly and accidental changes to formulae or information. Without close cooperation between team members, the risk of their information not matching central data only increases.

This silo effect when teams or individuals carry out their own work but do not communicate effectively with others can lead to mistakes, duplication of work, and missed opportunities; such as a trader not being aware of the opportunity to profit from a low-cost scheduled vessel or an operator being unaware of an upcoming shipment. Without taking errors into account, each small missed opportunity creates a slight impact on margins that across all trades over a year can represent a significant loss of earnings.

The right risk management support can address all of these operational risks and more. Gen10’s commodity management solutions incorporate operational risk management in a number of ways, including controlling processes, providing complete visibility between teams, eliminating the need to copy data and making risk data available in real-time as things change so that traders and operators can make better strategic decisions.

Because Gen10 solutions use process automation to manage commodity trading, operations and risk, all activities are carried out in the system, with no need for spreadsheets or other documents. The automation means that using the commodity management system is faster and easier for traders and operators, automatically calculating pricing, creating documents and progressing contracts to the next stage. As all activities are carried out in one system, there is no risk of local documents failing to match central data and risk managers have a complete view of all activities in real-time as things change.

This real-time data visibility benefits all teams across the business, from those using it to create more profitable hedging strategies, to risk managers, traders and operators who have all the information they need, whenever they need it, to ensure they are creating the best outcome from their actions. Data access becomes even more important in periods of disruption: storing all data in one place with secure access for those who need it is essential for the effective and flexible reporting that helps businesses react quickly to new situations.

With recent market disruption, risk management has been high on the agenda to protect businesses. However, employing the best technology to support rigorous risk management not only mitigates risk and protects the business; it can provide the edge that metals traders are looking for to protect and grow profit margins.