TECH TUESDAY: Managing Commodity Risk

Real-time, cloud-based risk platform optimizes trading firms’ resilience through price spikes.

While commodity prices have come off peak levels reached in the second quarter, there is still volatility in the market and an uncertain outlook heading into the fall - amid the ongoing war in Ukraine and a looming slowdown in the global economy. 

In a research note published the week of August 8, Goldman Sachs analysts noted that the commodity price decline since June is due to market participants shifting from hoarding supplies to ‘destocking’ on the premise an economic slowdown will lower demand and add supply. “Yet should this prove incorrect and excess supply does not materialize as we expect, the restocking scramble would exacerbate scarcity, pushing prices substantially higher this autumn,” the research note said.

Whether commodity prices’ next spike will be later this year or sometime further out in the future, what 2022 has taught us is that commodity price spikes happen, and trading firms need to be equipped to handle them.

One key consideration is initial margin, the percentage of a security’s purchase price that must be held in cash. Commodity price spikes force initial margins higher at central clearing counterparties, squeezing trading firms’ collateral and liquidity and stressing technology stacks and risk controls as workarounds are sought.

Advanced technology, such as real-time risk management system, Nasdaq Risk Platform, can help commodity trading firms efficiently manage margin requirements and thus not be knocked off course in the event of a price spike.

This risk system can replicate the initial margin on trades, improving visibility, enabling a more effective evaluation of the risk of executing a trade, and a more optimized trading strategy. It indicates whether it makes sense to execute on one venue versus another and calculates the initial incremental margin for a prospective trade. A trading firm knows exactly how much capital is required to keep aside for the initial margin to meet CCP obligations and how much can be invested overnight.

Additionally, real-time monitoring of trading activity and stress testing for volatile market conditions is critical to the futureproofing and resiliency of an organization. This enables more effective preempting of future margin calls by running various event scenarios to determine what liquidity is required in each circumstance. 

Nasdaq Risk Platform is delivered as a cloud-based SaaS solution, which reduces operational complexity. Clients can be onboarded quickly, allowing them to concentrate on their business instead of allocating resources to implementation, maintenance and software updating processes. Nasdaq Risk Platform enables firms to lower their total cost of ownership, reducing overall capital expenditures.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Traders Magazine, a Markets Media Group publication, caters to the institutional sell side, buy side and exchanges. Focused primarily on North American equity and options markets, Traders Magazine covers strategy, technology and regulation.

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