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Risk Management applied to Energy sector
20 January 2015
Sophie Topsent [email protected]
Stéphane Bertoncini [email protected]
Thibault Drillon [email protected]
Jean Ammeux [email protected]
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Assets Sales SalesOriginationLogistic
New business paradigm
Growing volumes on financial markets as opposed to ‘traditional’ physical deals
Consumption & production zones experience deep changes, with the emergence of ‘new’ commodities such as biomass, LNG, shale gas etc.
Prices are getting more market-driven, accelerating re-negotiation & arbitration between suppliers & consumers
Security of supply to face extreme situations (cold peak, production or logistical problems or political tensions) raise more and more concerns within political class and regulators
Regulations are piling-up on energy markets (‘trade reporting’ obligations induced by EMIR & REMIT, end of commodities exemption by MIFID 2)
… inducing booming complexity cost & constraints
Increased regulatory pressureChanging competition landscape
Banks massively disengage from commodity trading
…… while independent trading houses are booming
More globally, competitive intensity increases under several combined factors:• Up-streamers developing trading skills• End of specific regulated tariff
Trading
ProductionGeneration Marketing
Energy markets have been subject to deep structuring changes in the last few years …
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… placing more than ever Risk Management at the heart of business steering
Method & modelling Identify & map Risk Factors Measure Risk Indicators
Governance Risk mandates Deal / trade authorization
Strategic guidance Risk appetite Survival horizon
Market Risk Physical Risk Credit Risk Operational RiskLiquidity Risk
Monitor & Report risks
Allocation – Optimization Strategic scenario & measurement
Risk committee(s) Limits
IPV & model validation Reserve policy
Risk Management in energy sector uses techniques that are derived from those prevailing on financial services … but with strong specificities on activities, market rules and regulation
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A specific business model, articulated around 3 segments of activity, each corresponding to particular risk profiles and practices
Portfolio management & optimization
Asset-backed trading Trading
Risk hedging decision are taken ex ante on a global basis, with a ‘long-term’ horizon (up to 3 to 5 Y)
Hedging policy is re-adjusted on a regular basis (monthly), leaving some room for ‘short-term’ arbitration strategies
Risk taking and hedging decisions are taken ‘spot’, on an individual basis, within global risk guidance and limits
Strategies are dynamically monitored and constantly re-adjusted depending on market opportunities
Business orientations are decided based on positions transferred from portfolio and market anticipations
Combining constraints and views from portfolio and trading sides
ex post risk measure is performed on a daily basis, with ‘advanced’ indicators and stress scenarios
Long-term sourcingAssets and capacitiesGlobal hedging strategies
Integration of portfolio and trading activities generally creates value, provided that proper framework is in place to have a consolidated view of risks on heterogeneous activities
Hedge optimization & arbitrage Market makingProprietary Trading
ex post risk measure is generally performed with ‘basic’ indicators, often on a weekly basis
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Energy markets obey specific rules, corresponding to specific risks
Physical assets (planned or unexpected unavailability, impact of climate such as temperature, mater level etc.)
Time & geographical spreads (storage & transportation)
Physical risk Market & Liquidity risk
• Shape risk (for deals with non standard volume profile)
• Decline of sacrosanct oil index (on LT gas contract)
• Limited liquidity horizon (3 to 5Y maximum)
Counterpart risk
Many players on energy markets are industrial, non rated counterparts …
… operating in politically unstable regions
Operational risk
Nomination and balancing require implementation of 24/7 processes …
… with financial losses set to increase due to strengthening of imbalance penalties (over European Gas markets)
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Many players on energy markets do not fall within risk / capital regulations generally applying to financial services
Several reasons for this ‘exemption’:• It is possible to operate / speculate on energy
markets without banking or financial serviceslicense
• Some market regulations specifically excludecommodity trades from their scope (ex. MIFID)
Nevertheless, all players in the industry shouldtake a close look at risk regulation:• Commodities exemption could come to an end (as
MIFID 2 may introduce capital requirements for non-banking players)
• Regulation is a source of methodological insights and good practices even for companies that are out of implementation scope
• Regulatory constraints can be transformed into business opportunity (as an illustration, a performing client on-boarding process can reduce time to market and contribute to sound credit / counterpart risk management).
Modelling & quantitative skills are critical when it comes to turning regulatory constraints into business opportunities
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Implementing cutting-edge modelling techniques requires investments all along value chain
Portfolio optimization runs
Deal quoting & pricing
Pre-deal checking
MtM & Risk measurement
Reserve policy
Modelling technique
Data Quality Storage & computation
Real time & simulation
Putting in place advanced modelling techniques requires
the right level of expertise in Research
& Development as well as Risk
Methodology teams …
People Process Systems
… along with implementation of proper processes to
guarantee exhaustiveness &
accuracy of exposures and calculation
parameters
It also implies adequate hardware investment, both on
storage and computation capacity
as well as human investment to ensure transformation and
continuous improvement
Real time and simulation
functionalities must also be implemented
in order to take advantage of short term opportunity window and take
appropriate pre-deal decisions
Risk Management functions are shifting from a mere measurement tool to a business-oriented instrument with strategic guidance
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Pricing & valuation
Measuring and capturing market & physical risks
Covering other financial risks
Developing advanced techniques for rare risks & complex instruments
Optimizing profitability & managing business portfolio
Computing multi-dimension risk / performance monitoring
Defining targets and steering strategy
7Solving complex multi-variable equations linked to strategy
MtM, MtModelMtM @ risk, sensitivities, VaR & PVaR
Stress Tests, Reputational risk, exotic instruments valuation
Risk Appetite, RAROC, Risk Reserves (CVA –DVA – FVA)
Credit – operational risk
P&L, financial & physical B/S, liquidity
Competitive positioning, Ideal target product mix, portfolio structure optimization...
EVA / Earnings Volatility, Strategic Planning
Stat
icB
usi
nes
s In
tegr
ated
Dyn
amic
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Some ‘hot topics’ should require particular attention in short or medium term
Prudent Valuation
AVAs (CVA / DVA / FVA and other value adjustments) have been reflecting sound valuation practices, before getting regulatory or accounting requirements
Dynamic Risk Hedging
IASB is willing to take one (big) step forward on the path of risk / finance convergence by widely opening the door to recognition of dynamic hedging on commodity price risk in financial statements
Big Data
Big data revolution is in motion in the energy sector as implementation of profitable strategies requires processing and interpretation of a growing flow of data.
Keeping in mind that in a highly competitive environment, missing the Big Data boat could cause disastrous shipwrecks.
MiFID 2
The exemptions currently available to commodity derivatives trading firms shall be significantly narrowed
Firms will be required to be authorized by their home State regulator and will be subject to capital requirements along with rules on position limits and reporting.
Ukrainian crisis
Several impacts to be monitored (UE and US sanctions, update of stress scenarios in case of move to ‘step 3’ measures)
The new balancing network code changes the paradigm over energy marketsThe new balancing rule to be implemented by 2015 reduces players room of manoeuverAs impact of imbalance shall be billed at marginal price a necessary evil
CH&Cie GRA team can help you successfully facing today’s and tomorrow’s risk challenges
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Global Research & Analytics© Dept. (GRA): an holistic vision of Risk Management
GRA expertise center covers a wide array of interventions on Risk Management topics, and provide clients with bespoke solutions adapted to their activities and risk profile.
GRA team can assist you on every aspect of your Risk Management framework
Risk appetite & strategic planning ICAAP Optimize RWA & capital consumption
Method & modelling
Strategic guidance
Governance
Monitor & Report risks
Internal model homologation AQR & Stress testing
Design / streamline risk governance framework (mandates, committees etc.)
Design / streamline client on-boarding process (KYC, AML etc.)
Design or transform Risk Management framework (centralized / decentralized model –risk & finance articulation)
Design / streamline risk dashboard Hypothetic P&L – VaR back-testing
Design models and pricing tools Audit models or pricing tools Run back-testing
CH&Cie at a glance: a management consultancy for Financial Services & Commodity players
150 consultants, with solid academic background and experience - 7 years in average - who serve our clients across Financial Services and Commodity industry
8 offices around the world, in major trading and financial places…
Customer Experience
Risk & Finance
IT & Operations
Business Development
4 areas of expertise
Commodity trading, portfolio management, Trade Finance
Insurance, Asset Management
Retail banking, Private Banking & CIB
… and 3 centres of expertise
Global Research & AnalyticsCentre of Expertise
Regulatory PoleCentre of expertise
Digital LabTechnological Innovation
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Some of your interlocutors on risk and commodity issues
Ziad Fares
Manager @ the “Global Research & Analytics” team
Ziad has gained deep knowledge over financial industry, acquired at Risk position in a Big 4 consulting firm (Quant department)
Supelec – academic research on commodities / renewable energy
+33 6 62 96 25 [email protected]
Benoit Genest
Partner – head of the “Global Research & Analytics” team
Benoit has gained deep knowledge over Risk modelling, Valuation and risk management
He has led many projects both in the commodities and Financial industries, with special focus on models validation & implementation (CVA, CVaR, IFRS 13 …)
+33 7 87 68 81 [email protected]
Director – head of Commodities team
Sophie has gained deep knowledge over Trading activities through various consulting or operational positions within the industry, with a special focus on Risk & Performance monitoring.
Sophie has been in charge of the Regulatory Pole within a leading consulting & audit firm
HEC graduate – exch. In MBA program at the UBC (Vancouver)+ 33 6 40 56 21 [email protected]
Sophie Topsent
Stéphane is CH&Cie CEO & leading Partner
He has led many strategic projects both in banking and energy industries, with a special focus on risk and performance management
+ 44 78 34 55 03 [email protected]
Stéphane Eyraud
Manager @ the GRA team
Augustin has been responsible for the initial setup and day to day management of Commodities FVA desk at JP Morgan
He has also ensured risk management of a Commodities index book and pricing-execution of investor products
Audencia School of management and Ohio State University with a specialization in Finance
+33 1 43 18 13 [email protected]
Augustin Beyot
