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Risk & Compliance

Optimizing Risk Management in the Energy Markets

These radical price swings as we move from one crisis to the next can create significant challenges for energy firms. In order to effectively manage risk in real-time, energy firms should be thinking about a few key themes in the risk space.

Looking back on the last couple of years, energy prices have seen a substantial amount of volatility. Lockdowns during the COVID-19 pandemic zapped demand for oil and natural gas, causing prices to plummet in 2020. Next, the global economic recovery induced by widespread vaccinations along with extreme cold weather and supply chain disruptions – not to mention the long-term shift away from fossil fuels to renewables – resulted in skyrocketing prices in 2021. Then came Russia’s invasion of Ukraine in February 2022, which sent oil prices to their highest levels since July 2008.

These radical price swings as we move from one crisis to the next can create significant challenges for energy firms, many of which are seeing their technology stacks and risk controls being put to the test. For firms facing these challenges, this can be a wake-up call to evaluate whether they are managing financial and reputational risk effectively. 

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

Consider what happened to the Bank of China in 2020. When the price of oil went negative, the bank was faced with absorbing part of $1 billion in retail client losses on its Crude Oil Treasure investment product. Ultimately, it was fined about $7.73 million over irregularities, and it incurred significant damage to its reputation.

Recent events in the nickel market should also resonate with energy firms. In early March 2022, the price of nickel surged about 250% in two days to trade briefly above $100,000 a ton, prompting the London Metal Exchange to suspend trading. Investors and industrial users who had sold nickel hustled 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 are no longer able to meet today’s risk management requirements. In order to effectively manage risk in real-time, energy firms should be thinking about a few key themes in the risk space:

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

Regulators expect firms to have comprehensive risk management programs with sufficient reporting to back up risk decisions. Solutions need to accommodate the Standard Portfolio of Risk (Span 2) framework for exchange-listed products, which is 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 that has been developed using modern cloud-native infrastructure improves agility, makes it easier to deploy new solutions – especially data-intensive ones – enables scalability and flexibility, and it’s also cost-effective.

3. Centralized systems are better at managing and optimizing collateral and capital.

Pre-trade, a centralized risk management system can help firms determine which venue is the optimal place to take a position. Post-trade, energy firms must put up collateral at the clearinghouse. Portfolio or cross margining — combining positions in different products to offset margin — may help firms to optimize their collateral and manage capital efficiently. Utilizing these pre- and post-trade tools can have a positive impact on the bottom line. 

Evaluating your Current Risk Platform

To manage risk, many firms rely on in-house monolithic systems or multiple disparate systems that don’t communicate with one another, let alone cover multiple asset classes in one centralized 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 inefficient capital allocation, these systems tend to run at a high total cost of ownership despite these deficiencies.

Where to Start

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

The Nasdaq Risk Platform was constructed to improve cash efficiency, reduce operational and regulatory risk, and provide a single risk view in a modern, cost-effective and scalable solution deployed in the cloud. Nasdaq’s product experts continuously expand both the breadth of the product and the depth of features and functions. These have been developed in an agile manner in partnership with clients and in lockstep with the market needs. As such, the Nasdaq Risk Platform is a solution that lowers the total cost of ownership while staying ahead of energy firms’ risk management needs.


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