Optimizing Risk Management in Energy Markets – Nasdaq | Region & Cash

LLooking back over the past few years, energy prices have experienced significant volatility. Lockdowns during the COVID-19 pandemic saw demand for oil and natural gas fall, causing prices to plummet in 2020. Next came the global economic recovery fueled by widespread vaccination combined with extreme cold and supply chain disruptions — not to mention the long-term shift away from fossil fuels toward renewable energy — led to skyrocketing prices in 2021. Then came Russia’s February 2022 invasion of Ukraine that sent oil prices to their highest levels since July 2008.

These radical price volatility transitions from one crisis to the next can pose significant challenges for energy companies, many of whom are testing their technology stacks and risk controls. For organizations facing these challenges, this can be a wake-up call to assess whether they are effectively managing financial and reputational risk.

In volatile conditions, companies need to be able to assess their liquid capital in real time to ensure it is optimized for capital efficiency and to manage the potential impact on profit and loss. At the same time, they must be able to meet margin calls from clearing counterparties.

Consider what happened to the Bank of China in 2020. When oil prices went negative, the bank was faced with absorbing a portion of the $1 billion in retail client losses on its Crude Oil Treasure investment product. Ultimately, it was fined approximately $7.73 million for irregularities and suffered significant reputational damage.

Recent events in the nickel market should also resonate with energy companies. In early March 2022, nickel prices surged about 250% in two days and briefly traded above $100,000 a tonne, prompting the London Metal Exchange to suspend trading. Investors and industry users who had been selling nickel rushed to cover their unprofitable short positions after prices initially rallied on concerns about supplies from Russia. Meanwhile, brokers rushed to collect margin payments from their clients.

The batch-based solutions of the past no longer meet today’s risk management requirements. To effectively manage risk in real-time, energy companies should think about a few key risk issues:

1. Regulators have high expectations and the rules are changing.

Regulators expect companies to have comprehensive risk management programs with sufficient reporting to support risk decisions. The solutions must take into account the standard Portfolio of Risk (Span 2) framework for listed products being rolled out at the CME and VaR-based models for OTC derivatives.

2. Cloud is the future.

Managed cloud-based Software-as-a-Service (SaaS) solutions increase efficiency and reduce operational risk. Technology built using a modern, cloud-native infrastructure improves agility, makes it easier to deploy new solutions—especially more data-intensive ones—allows for scalability and flexibility, and it’s also cost-effective.

3. Centralized systems can better manage and optimize collateral and capital.

Before trading, a centralized risk management system can help firms determine which trading venue is the optimal place to enter a position. After trading, energy companies must deposit collateral with the clearing house. Portfolio or cross-margining – combining positions in different products to even out margin – can help companies optimize their collateral and manage capital efficiently. Using these pre and post trade tools can have a positive impact on the bottom line.

Assess your current risk platform

To manage risk, many organizations rely on internal monolithic systems, or multiple disparate systems that don’t communicate with each other, let alone spanning multiple asset classes in one central location. As a result, it can be difficult to calculate margin intraday or in real time, which can lead to underutilized capital. In addition to an inefficient allocation of capital, these systems tend to run at high total cost of ownership despite these shortcomings.

Where to start

The Nasdaq Risk Platform provides real-time initial margin monitoring and margin allocation across multiple CCPs, real-time risk measurements, limits and alerts, and regulatory calculations. While these are essential to any real-time risk system, the Nasdaq Risk Platform includes many other features and functions designed to improve efficiency. Additionally, as a cloud-based SaaS-based solution, it saves risk managers time and is cost-effective.

The Nasdaq Risk Platform is designed to improve cash efficiencies, reduce operational and regulatory risk, and provide a single view of risk in a modern, cost-effective, and scalable solution delivered in the cloud. Nasdaq’s product experts are continually expanding both the breadth of the product and the depth of features and functionality. These were developed in an agile manner in partnership with customers and in step with market needs. As such, the Nasdaq Risk Platform is a solution that lowers the total cost of ownership while staying ahead of the risk management needs of energy companies.

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