This post is part of our unorganized research and survey which we have done across multiple industries and geographies, to find out the top 5 issues with Commodity Risk Systems that are being faced by the trading companies. While many companies are likely to have one of these issues, some might even be in more than a single category. So, even if your organization falls in one of them, you might want to go through the other categories as well so as to know in advance the other pitfalls to avoid.
1. Spreadsheet based Risk Systems:
Spreadsheets are probably the most common reason for majority of commodity players struggling with their Risk Systems. They started with some simple spreadsheet based process for managing risks, and it got overly complicated over time. In fact, research has shown that despite nearly 94% of spreadsheet containing errors, about 45-50% of Commodity players still rely on spreadsheets for managing commodity price risks. No matter how much thought goes into this, there is simply no solution to make spreadsheets work as efficiently and accurately as a software solution. We’ve covered this topic earlier in our blog-post 6 reasons why you should trash your existing Risk Management System, and our white-paper 5 reasons why Spreadsheet based Risk systems won’t work.
A software solution not only provides checks for data integrity and security, but also keeps an audit log of all actions taken on data within the system by all users. This eliminates chances of data manipulation by a trader who has had a really rough week! A well-designed system will actually store all the transactional, risk and meta data in a single data warehouse and allow users to tap into historical reports with a single click. Besides, thousands of simulations for pricing derivative deals and for VaR calculations can be done far more easily and quickly by a system as compared to a spreadsheet.
2. Multiple systems for Risk Management:
Having a number of systems, connected to each other in myriad ways is another area of deep concern for the commodities industry. Research has shown that among all the commodity players who have an established Risk Management Function, as many as 80% of them have more than 2 systems to manage their commodity price risks. For a significant 25% of the commodity companies, the number of systems in use for risk management goes over 5! It doesn’t take much IT knowledge to figure out how that would pan out for those companies. It is best described in one word – Chaos !
A good VaR Solution should be able to replace almost all of these disparate systems at one go. This will definitely enable seamless flow of data, lesser time spent on reconciliations, and a “Single Source of Truth”. The benefits of doing this go far beyond data integrity though. The amount of time saved by IT division in maintaining all the systems can be used to speed-up responses from the remaining few systems, put fail-safe measures in place, create and follow a Business Continuity Plan and ensure that data security measures are updated to tackle the latest threats. The time saved by Risk Management and back-office divisions in reconciliations and report generation can be utilized for faster reporting, realistic simulations done on a daily basis, and increasing the breadth and depth of analysis.
3. Unscalable In-house developed / vendor Solutions:
This is by far the toughest situation to come out of, primarily due to the time and effort that has gone in developing and implementing these systems. For in-house developed systems, several customizations are made keeping in mind the unique needs of the business and some of these cannot be transitioned to a new system easily, or even at all. Sometimes IT division’s job insecurity plays a crucial role in demanding that the existing systems be allowed to run and improve further with more investments.
In cases where an unscalable third party vendor solution exists, the money spent on procuring any existing vendor solutions will be seen as wasted by various stakeholders if the request for a new system comes up. These and many such apprehensions keep people away from replacing existing systems, even-though they are probably as unscalable as spreadsheets. While these reasons cannot be over-looked, the crux of the problem still stays the same – unusable, unscalable risk systems. In most such cases, the only people who use these systems are the IT team and some Risk Analysts. The consultants for such systems are sometimes unaffordable or unavailable making it very difficult for Risk Management team to keep up their understanding of the system and desirable changes in it.
However, it needs to be realized that there are merits in moving on to a better solution, one that can actually add value back to daily decision-making and strategy and improve profitability. The sooner that happens, the better it is for all stakeholders !
4. Connecting with Existing Transaction Systems:
Nearly all companies in commodity trading business have unique processes and therefore unique systems. These systems can be ERPs, Commodity Contract Management Systems, trading systems, and spreadsheets. Most of the existing risk systems cannot connect seamlessly with them, giving huge discomfort to the management. They understand that unreliable output is equivalent to no output at all. This results in fall in demand for risk systems’ output (reports, analysis). Moreover, as commodity management systems change along with evolving business processes, risk systems are left behind.
While poor integration with existing transaction systems might not be the biggest reason for failure of risk systems, it is a pretty significant one. Taking an end-to-end integrated system also does not necessarily solve the problems. It is most of the times considered wise to choose the best suited solution in each area and work with different vendors on seamless integration. Such measures ensure that while there might be more integration points across the systems, each one allows free-flow of data and gets the best out of each system.
Given the geeky nature of many Risk Analysts, the risk systems too are presumed to be geeky and less user-friendly. Users have to struggle at nearly everything – from uploading transactions in pre-specified format, uploading volatility-correlation matrices and prices, to reporting and analysis. It all seems logical until someone decides to bell the cat. And then it slowly dawns on everyone that a system that is not user-friendly is not going to get used, irrespective of how many other customers it has and how complex and geeky it sounds.
The ease of use of the system is not solely related to the user-interface or “look-and-feel” of the system, but with ease of carrying out the operations that the system is required to. For a risk system, these operations would include dynamic reports, automated alerts, and easy simulations at the very least. Moreover, according to some recent global surveys on Risk Management, data management is one of the top areas of concern for all companies. So the latest Risk management systems need to address these issues as well in a very significant way.
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