Following up on the huge response to our Blog post “The Evolution of Commodity Risk Management“, we answer some of the most pertinent questions raised by several people in this blog post – The Future of Commodity Risk Management. Here we share what we think how Commodity Risk Management is going to change in the Future for companies that today, either don’t have a well-established risk management process or are struggling with their processes. As we talk to industry experts and commodity companies, here are the top 5 trends that seem to be emerging quite clearly:
Changing consumer preferences, aided with several research-driven commodity products are creating havoc for many companies trying to predict supply and demand for their products. Not only does it make a mockery of their medium-term procurement and sales plans, but also creates ripples across the entire supply chain leaving top management wondering if there is a way out of this ! While there’s always the crystal ball – but for those who don’t have that luxury, there is no option other than a better, more robust Risk Management Process. This growing need for better Risk Management is being increasingly captured by various global surveys being conducted across different industries that point out interesting trends.
Some of the trends that stand out are:
- CRO positions being created within companies from dismal levels in early 2000s to nearly 90%+ today
- More significance being attached to Risk Management Function, and its proximity to the board
- Realization that there is still a long way to go in achieving longer term earnings growth and reducing losses through better risk management
- Adopting better ways to ensure Risk Data quality
We expect this trend to grow stronger and actually taking shape through action – with boards and management teams better equipped to understand the intricacies of Risk Management and constantly looking to improve their risk processes.
2. Integrating Risk Management with Business Management:
Instead of operating Risk Management Silos that churn out End of Day reports that no one really looks at and provide numbers that no one understands / acts on, companies are increasing realizing the need for integrating their Risk Function with their daily operations. This too has come up as one of the top priorities of CEO of many medium to large sized energy / commodity players.
[For those interested in reading more about this concept, we’ve covered it in one of our earlier blog posts “Why everybody in your organization is a Risk Manager“]
Today, the Board, shareholders and bankers of commodity players are all looking at not just in-house capabilities in managing risks, but also whether the team is able to derive deeper insights into business through better risk management. This requires various teams within the organization to be aware of the risk appetite of the company, and openly discuss critical scenarios with each other to categorize various risks into acceptable and un-acceptable categories. This in turn requires a healthy risk-culture to be developed within the organization – something that the top management in most companies is already aware of.
We expect this thought process to be implemented consistently over years in most organization going forward, till such time as risk management becomes as much a second nature of decision making as profitability.
3. Math is important, Understanding Risk Management is more important:
Complex mathematical model for valuations and risk calculations has traditionally rendered Risk Management as a niche area reserved only for geeks, creating a huge chasm between the business heads and risk management function. To add to these woes is the acute lack of availability of talent that understands business processes and risk models along with skills to articulate the linkage between the two for top management. The end-result is a fiscal-deficit sized gap between the business requirements and risk function’s deliverables. This is also one of the most important trends that will catch up with the commodity players sooner rather than later, as they realize that its far more important to understand and apply risk management concepts to their business strategy and daily decisions rather than getting lost in mathematical models. What’s more, this will be achieved while keeping an eye on customizing algorithms to model energy and commodity return distributions better, thereby achieving better estimations of valuations and risks.
You might want to refer to our blog-post Commodity Risk Management beyond VaR to see a simple example of how seemingly complex mathematical equations can connect with business heads easily once they are translated into plain business language with application to managing risks better.
4. Scalability, Scalability, Scalability:
Only those who have actually struggled with their existing risk management system will really understand the pain involved in dealing with non-scalable systems. Business Processes change all the time based on macro- and micro- economic environments, and its well neigh impossible for older systems to keep pace with these changes. By the time systems are made to adapt to the new reality, the new reality isn’t that any more, triggering another futile round of catching up. The reason is most systems, irrespective of what they cost, weren’t designed to adapt to these changes quickly – it is the system design that plays the most crucial role here. Beautiful engineering design, by definition, is not easily seen but perceived – and it is that design that allows us to understand the system intuitively and work it to our advantage under multiple seen / unseen situations. A good system scales up with the business.
We expect the future of commodity risk management will be driven by stand-alone risk systems that can adapt to commodity business processes, and are also capable of integrating with other myriad systems with ease.
5. Technology and Device Adoption:
Compared to the Banking and Financial Services industries, risk management in most commodity companies has always been an under-achiever. And it is not the significance attached to this process that’s the real culprit in many cases, rather the outdated technology being used for managing risks. While most users in such companies have adopted latest web-technologies with social media and some other enterprise applications, most Risk management users are still stuck with age-old legacy systems or spreadsheet / library based systems that take forever to run simulations, if they can at all. Most surveys still show Data management and GIGO (Garbage-In-Garbage-Out) issues as top concerns for users of Risk Management systems – just when evolved industries are winning Big-Data challenges with relative ease ! We expect most of the users to move to touch-based devices by late 2014 to mid-2015, creating yet another generational gap in the systems available and current technology.
We expect that the companies will move towards closing this generational gap soon and a huge churn in existing risk applications is in store. This process is set to continue until we have all applications that fit in 3 categories – the ones that have bridged the gap and the ones that are fast moving towards it…:)
Among all the trends that we noticed, we believe these 5 trends are going to create the maximum impact on the way Commodity Risk Management is thought of, designed and implemented in most energy / commodity trading companies. Driving these trends is a growing belief that relatively faster growth will come not from avoiding risks, but from accepting the risks and managing them well.
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