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C. Statistics |
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Intro
to CTRM Software
Overview
Commodity
Trading and Risk Management software (CTRM) is software that combines the
functionality of ‘Trading’ and ‘Risk Management’ for commodities.
For clarity, a
system that does only risk management would be a ‘risk management system’ or
‘commodities risk management software’ and not be considered CTRM, which refers
to the combination of those functions.
History
CTRM Software
began around the 1990s with such companies as OpenLink (founded 1992) and
Allegro (founded 1988).
Reasons for
the creation of CTRM software include:
a)
Deregulation in the energy markets led to an increased need for risk
management, which meant that firms that had trading systems looks to add risk
management functionality.
b) In the
earlier days of vendor software for commodities trading, there would have been
separate software packages for trading and for risk management, similar to the
way word processing software and spreadsheet software used to be sold
separately and was later combined, e.g., Microsoft Word and Excel combined into
Office.
Trading Functionality – Common Features
These are the
most common features in CTRM software for Trading
functionality:
1) Trade
Capture
This is the
ability to enter ‘trades’ into the system.
Variations include
1.1) Manually via a screen in the system (‘via the GUI’). This could be via a:
1.1.1) ‘Trade
Blotter’, which has one row per trade (or sometimes one column per trade)
1.1.2) Trade
Input screen, i.e., one trade takes up the whole screen.
1.2) Import
from file. Files could be
1.2.1) Text
files, such as CSV.
1.2.2) Native
Excel or Excel compatible
1.2.3) XML format.
1.3) Direct
feed from:
1.3.1) An exchange, e.g., ICE or NYMEX
1.3.2) A broker
2) Trade
Retrieval and Viewing
This is the
ability for the user to request the system to load selected trades for
viewing. This could be, for example, all
trades for a certain date or all trades for a certain
counterparty. There would also be a screen (or web page), where users could see
the list of trades that meet the search criteria and potentially allow for
multiple reports where different attributes of the trades, e.g., quantity,
price, start date, end date, counterparty, are shown in different column
configurations.
3) Ability to
apply settlement prices to trade so as to calculate payments.
A typical
trade will require prices that are unknown at the time the trade is done to
later be applied to the trade so as to calculate a financial payment. For example, a trade done in May might be for
a firm to receive 10000 Barrels physical crude oil in December (so some months
after the trade date) and to pay the average of the December closing prices, with
the payment due date on the 20th of the following January.
In this
example, a trading system needs the ability to take the average price, e.g.,
$51/BBL, and use it to calculate the payment, which is just price times
quantity so 10000 BBL * $51/BBL = $51,000 payment.
Note that this
is not part of a risk management function.
Calculating a payment based on closing (a.k.a., ‘settlement’) prices is
done after the fact, i.e., after the prices are finalized and received, so this
process is not a forward looking calculation of market risk.
Trading Functionality – Additional
Features
These are
extra features related to the Trading function that some CTRM systems may
have. Even if a system does not have
these, it would still be considered CTRM.
The implication is that if a CTRM does not support these, a firm might
do them manually if firm is small enough, or a larger firm might have other
systems that perform these functions, with data fed from the CTRM.
1)
Confirmation
1.1) E-mail or
Fax
1.2)
Electronic Confirmation eConfirm
2) Invoicing
3) Broker Fee
3.1)
Calculation
3.2) Broker
tie out
3.3) Initial
and/or variation margin
4) Regulatory
Reporting functionality
Risk Management Functionality – Common
Features
When the term
‘risk management’ is used, it is typically used to refer to market risk, which
is the risk that market prices move against you, i.e., the risk that you lose
money because of adverse market price moves.
There are
other types of ‘risk’, such as ‘Credit Risk’, which is the risk that a counterparty does not pay you money that it owes you.
CTRM systems
need at a minimum functionality related to market risk. While some CTRM systems may have
functionality related to credit risk or other kinds of risk, those are not
required for a system to be considered CTRM.
1) Ability to get
a MTM (Mark to Market) for a Trade
MTM, also
known as ‘Present Value’ or ‘Valuation’ is the most core feature of a risk
management solution, as other aspects of risk management are dependent on being
able to value a trade.
In order for a
system to calculate the MTM for a trade, it needs to have the ability to have
forward prices (a.k.a., ‘projected prices’). For example, if in May, a system
needs to value a natural gas financial swap (a derivative trade) that runs from
January to December of the following year, it needs to have forward prices for
those future months.
Forward prices
would typically be fed in from an exchange, e.g., NYMEX, or some other price
source.
So long as the
prices are for months in the future, they will fluctuate daily, which is what
generates market risk. However, after
the month in question, the prices are finalized based on the closing prices
(a.k.a., settlement prices) and, since the now historic prices are no longer
fluctuating, there is no longer market risk.
2) Ability to
Calculate Market Risk Position for a Trade
The risk
management component of CTRM software needs to be able to both calculate and
report the price sensitivity for a trade, which is how much money a firm will
make or lose for a small, usually $0.01 or $0.001, move in the market price of
a commodity. This is sometimes called
the ‘delta’ of a commodity, one of the ‘greeks’.
3) Price Shock
Reporting, A.K.A., Stress Test, A.K.A., What If Analysis
The risk
management component of CTRM software needs to be able to simulate how much
money a firm will make (or lose) if market prices move up (or down) by a
certain predetermined amount, for example, up 10%. A stress test report might show the results
of multiple market price movements in a combined report, e.g., -10%, -5%, -2%,
-1%, unchanged (for a baseline), +1%, +2%, +5%, +10%. Note that this does not take into account
probabilities. So, for example, a system might calculate the change in the MTM
of a trade or set of trades for a +10% move in the market, without indicating
how likely it is that such a move will happen.
4)
Value-at-Risk
Some CTRM
systems may also be able to calculate VaR (Value-at-risk) as part of their
overall risk management capabilities.
This takes the concept of a ‘Stress Test’ (change in market prices) and adds probabilities.
For VaR, a typical percentage is 99% or 95%, where that probability is
interpreted as the probability of losing less than the VaR amount is 99%. So, for example, if the VaR is reported as
$1m at a 99% confidence level, then there is assumed to be a 1% chance that a
firm will lose more than that amount.
CTRM Systems – Commodities Supported
CTRM systems
commonly support the following commodities.
1) Energy
1.1) Natural
Gas
1.2) Power
1.3) Crude
1.4) Refined
Products
2) Base Metals
3) Precious
Metals
4) Softs/Ags
CTRM Systems – Trade Types Commonly
Supported
1) Exchange
Traded Futures
2) Commodity
Swaps
3) Commodity
Option
4) Physical
Commodity Trades
CTRM Systems – Addition ‘Non Trade Types’
Commonly Supported
For a system
that supports physical trading, it will often have support for these items,
which are similar to trades in that they have a value (MTM) and market risk,
but are not necessarily considered ‘trades’ because they don’t have a simple
start and end date.
1) Inventory
1.1) Balance
MTM and position
2) Storage
2.1)
Physical-owned storage
2.2) Contracts
to use storage from other first
3)
Transportation Contracts
Rights to use
pipelines to transport natural gas, i.e., long term contract with pipeline service
provider like Transco.
Scheduling
CTRM software
that supports physical trading will also have a third component called
‘scheduling’ also called ‘logistics’ or ‘commodity management’.
Items that are Not Common Features of CTRM
1) Cash
Applied
2) Data
Warehouse
3) Accounting
Sample CTRM Vendors and Software Packages
1) Vendor: ION
Group
https://iongroup.com/ion-commodities/products/
a) OpenLink
‘Endur’
b) Allegro
‘Horizon’
2) Vendor: Enuit
a) ‘Entrade’
3) Vendor: ComFin Software
a) Comcore
b) TheBulldog