CREDITRISKMANAGEMENT
energy firms are multi-faceted entities with multiple legal identities, ing days if not weeks to conduct a full
and diverse credit functions with different risk appetites and assess- credit assessment; or you turn the
ment methods. Taking into account all the contractual agreements, trade down completely; or you take a
covering all lines of business, legal entities, geographies, products gamble – depending on the risk
and portfolios, plus those of the particular counterparty, and it appetite of the firm. The most com-
becomes clear that aggregating and measuring net exposure is mon scenario is to hold off until per-
impossible to do manually in a timely manner. mission has been granted to trade.
But permission comes from commit-
If last week’s numbers won’t do,
tees who typically meet once a
last quarter’s are certainly not going to cut it
month. By that point the opportunity
has long gone.
Unfortunately, credit risk – as distinct from market or operational There is therefore a growing call for
risk – had taken something of a back seat. The middle office was all financial metrics and assessment on
too often dismissed as the ‘police force’ of an organisation whose potential counterparties to speed up
soleoccupationispreventinganyoneelsefromturningaprofit.They any future trades. Energy firms often
lack the profile, support or systems to match the supremacy of the cannot score counterparties more than
front and back office. Results are measured in terms of absolute annually, because the financials are
profit, not in terms of risk adjusted returns. And with multiple trad- only published once a year. Anyone
ing, accounting, pricing, scoring and logistics systems, most credit whodecidedtotradewithBearStearns
departments spend the majority of their day cleaning and collating in January based on last year’s num-
data.Onlyabout20%oftheirtimeisspentonmakingvaluedcred- bers understands this problem only too
it decisions that mitigate counterparty risks. well. An additional problematic factor
here is that the banks often have that
WhyCreditRiskManagement proprietary information and can score
The absence of an automated, integrated credit risk management counterparties more frequently.
system can prove to be a costly omission and certainly one that
impacts a company’s ability to operate in an optimum fashion. It ItCouldHappentoYou
could inhibit trading activity, could cause traders to turn away In today’s fast-paced, volatile and
opportunities or simply make bad decisions. inter-connected markets spreadsheets
You need to be able to make exposure calculations that take into no longer cut it in the middle office.
account which obligations have been paid and which haven’t. You Firmsneedsystems,processesandpeo-
need to take into account current and future exposure on expected ple who can guarantee that set proce-
physical delivery. You need to feed information from trading and dures are followed uniformly over a
logisticssystems–andreconciledatafromacrossthebusiness. globalbusiness.Diversecreditfunctions
For example, an inability to accurately calculate exposure daily with multiple risk appetites and differ-
meansyoucannotanticipatemargincalls,particularlyondealsthat entassessmentmethodscannotdeliver
gooutayearandmore,whichmakesitmuchharder,ifnotimpossi- optimum returns to shareholders and
bletoensureyouhaveenoughworkingcapitaltopayawaythatcall. cannot protect the business from other
Nor do you know whether to dispute that margin call. By the time players’ weaknesses.
youhaveworkedouttheveracityofyourcounterparty’sclaim
you have lost valuable interest and placed an even greater
Firms need systems, processes and people who can
strain on working capital.
guarantee that set procedures are followed
Current and future exposure on expected physical delivery
uniformly over a global business
also need to take into account. If this can’t be done then
companies have no way of analysing the impact of a deal that ini- Instead you need effective, automat-
tially looks attractive but which erodes profit by tying up working ed credit risk systems that can handle
capital for lengthy periods. thecomplexities–unlessyouareconfi-
Company profits can be eroded by extensive and unnecessary use dent that your shareholders can stom-
of credit lines. If you have global exposure to a counterparty you ach an 80% drop in overnight value.
mayhavecreditlinesavailableinSingaporetocoveratradethatwill Like all insurance problems, investing
exceedyourcreditlimitinEurope.Withoutadequatecreditriskman- after the event is far too late. Personal
agementyouwillsimplyendupapplyingforfurthercreditinEurope and corporate reputations depend on
andadditionalbankbackingandincurthesignificantcostsinvolved. it. After all, if it happened to Bear
Furthermore, the absence of credit risk management severely Stearns, so it could happen to you
•
impacts your ability to work with new counterparties, enter new
markets or exploit new sources of liquidity. A company that
Ian Sloggettis Sales Director, Energy
wants to expand into agricultural commodities, or extend its
Division with Financial Objects.
operations to new geographies is hampered when faced with a
new and unknown counterparty. Either you lose margin by wait-
www.finobj.com
COMMODITIES NOW SEPTEMBER 2008 79
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