Middle Office C/ETRM Defined
A done deal can immediately affect an existing portfolio’s market position, long or short. It is the risk manager’s job to see that the trade is managed from a portfolio perspective. This often involves hedging or balancing the portfolio with the goal of mitigating market exposure. This process is often accomplished using financial instruments. For example, options or commodity financial hedge instruments, such as NYMEX instruments, to “lock-in,” profits or losses by hedging or offsetting a long or short position with a trade.
Lifecycle of a C/ETRM Trade
Hedge positions must be maintained throughout a deal’s lifecycle and managed relative to the market movements. This may involve managing several ancillary trades or hedges that are tied to the original trade as neutral or offsetting (balancing) positions. These ancillary trades must be maintained from a deal capture/lifecycle deal perspective and they must be financially tracked with the original trade for a true profit & loss. This can be a challenge, as trades or hedges are constantly moving and expiring. Companies will often seek a C/ETRM technology system that is designed to track and maintain all trading and hedging activities.
Risk management is a discipline that is usually defined by an organization’s risk policy and procedures. Risk policies outline a company’s appetite or lack of appetite for taking on or mitigating risk exposure. It will also define how risk is to be handled with company assets and/or for speculative positions in the marketplace. Risk metrics, like value at risk measures are available to evaluate a trade or portfolio’s position against the market, often referred to as the “mark-to-market” position. The mark-to-market position is often managed by price curves that are market price snapshots of the position used to pinpoint the profit or loss associated with the portfolio or trade as market price movements affect the position.
Credit risk management is an important mid-office and front-office process that must be managed as mark-to-market positions may become “in the money” or “out of the money” to the extent that collateral may have to be posted.
Companies that do not have well defined risk policies often find themselves second-guessing when things go wrong. A well defined risk policy and procedure, along with a good C/ETRM system that complements risk policy & procedure, is recommended to manage this important and complex business function.