Being a software supplier to the world of commodity traders and mostly purchasers I have the opportunity to meet and speak with many involved in the agri-commodity industry, most of the time the conversations allow to a go a bit deeper than only market information as software forces you to understand the detailed processes in order to automate.
One of the things I noticed during all these conversations is the diversity on how people perceive market price risk and more prominent, the diversity on how they manage it. Obviously there is no good or bad, but although market price risk management has a long history apparently there is some lack of standardization. Apparently it is complex to standardize or find a real common approach, despite the existence of professional exchanges such as the Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE). Such and exchange would say that the answer is derivatives, being perceived as the fundamental risk management tool. I must admit that the exchanges do have a point here. What else would be more suitable to manage the risk of fluctuating prices? What I have seen over the last 20 years is that it is not the available toolset which creates the diversity in approach but much more the translation of the own situation towards the tool. Apparently the factors which determine the situation you are in makes it so complex to choose which derivatives and how to apply them and build a risk management procedure out of it.
Many times I ask people which derivatives they use to get some sense of how we can help them to automate or improve with our Agiblocks commodity trade and risk management (CTRM) solution, the feedback is always varying. Where one is not using them at all, the other has a complete range of instruments such as futures, options and OTC’s. Most of the time the answer lies somewhere in the middle. It must indeed be said that everything is depending on where you are with your business. Are you a pure trader or a producer who purchases commodities to make finished goods? The type of commodity puts another variable to it; each commodity has it specifics and dependencies of physical limitations, opportunities or sometimes missing a liquid market. The geographical location of the business puts another element to it. A local approach can demand a complete different market price risk management approach than an international one. When you all have considered those, then the legislation or corporate rules put their own influences to it.
Market perception
A very difficult one to catch is market perception, as a software person I follow the rules and the knowns. I am not having much of a vision on the price movement as what I know what the current price is. Sure, with fundamental analysis, listen carefully to the speakers at the specialized conferences and perhaps with some good prediction analysis tooling I can form an opinion. The other thing I did learn is that prices will fluctuate and it looks like very difficult to even predict the price movement direction for at least most of the industry experts. Last year I had the opportunity to be at the world leading sugar conference where almost the entire audience agreed that the price of sugar would not go lower, the opposite apparently happened. Proving once more the need for hedging practices without relying on market perception.
As a purchaser of commodities to make a finished product, I guess you should not want to speculate on a lower price, but if you don’t want that how then to protect myself? The protection can be done multiple ways, a direct sell of a future along with your physical purchase contract or you might want to go for the long option of futures. Should I instead work together with a financial institute to create a fancy OTC contract and get help of these experts? If I do that is then the fluctuation of the physical prince in line with the derivative? How do I manage then the differential between the two as that is a risk as well? These questions and real life situations can become pretty complex and if it is one contract you probably can sit with pen and paper on a rainy Sunday afternoon to check and calculate if your market price risk is covered. What if you have multiple, with multiple contracts they influence each other as well. Before you know it, a complex administration appears. To avoid that most people forces their risk management process to simplify. Otherwise it would be too complex to control it, but simplification of your process will limit your practical choice of instruments.
Software
It is one of the main reasons we have developed Agiblocks CTRM, simplification of the views and risk control, where at the underlying there can be sophisticated and complex contracts. Allowing you to focus on the deal and not on the risk control and risk management. Our objective is to have with a single touch the view on risk instantly. As a software provider it gives you the challenge to create something which can capture all this flexibility and possibilities in a single software solution. We wanted to go the extra mile and facilitated mechanisms to put up hedge requirements as a result of physical trades or purchases. That has not been easy and it explains also why we focus on certain markets. Before supporting a new market a CTRM software provider must be able to understand and facilitate all these specifics first as what we want is to provide our clients the maximum freedom and opportunity to use best derivatives for that specific situation without worrying about how to control the risk.
