In an era of tightening profit margins, high commodity price volatility and increased supplier credit risk, CFOs are increasingly turning to their treasurers for help. As treasurers are dealing with the complexities of foreign exchange, interest rate or credit risk on a daily basis, they have established risk management frameworks, and therefore, are trusted to efficiently handle commodity risk as well. In addition, treasurers are familiar with the nuances of changing hedge accounting and derivative regulations such as IFRS 9, Dodd-Frank or EMIR, all of which apply to commodities.
As commodities are added to the treasurer´s risk management portfolio, they have to decide how to approach commodity risk management. In basic terms, there are three types of commodity risk managers:
Basic Risk Manager – The Basic Risk Manager is a lonesome hero trying to identify and mitigate commodity risk through hedging. When it gets too complicated, for example there is no market data available, he/she just ignores the risks. As there is little exchange between the business units, there might be other lonesome heroes, also managing commodity risk. Additionally, risk definitions and appetite are differing from entity to entity, thus commodity risks are handled quite differently across the enterprise.
Silo Risk Manager – The Silo Risk Manager has identified material commodity risks that the organisation is exposed to and it is this risk manager’s responsibility to mitigate those centrally. Although it is a centralised risk approach, each risk is hedged on an individual basis. There is a corporate risk policy in place, and process definitions assure timely and cost effective execution.
Portfolio Risk Manager – The Portfolio Risk Manager takes a holistic approach to risk management and is keen to closely align commodity risk management to the business strategies. He/she does not only look at the commodity risk portfolio as a whole, but also considers FX risk associated with the commodity exposures. Natural hedges between different asset classes are considered when the hedging programmes are set up. Advanced risk management techniques such as Cash flow at Risk are leveraged to better understand and mitigate risk.
In general, the better aligned commodity risk management is with the business, the more value it can add. Therefore, leading organisations are evolving their commodity risk management function from basic risk management to portfolio risk management. Aside from establishing enterprise-wide risk policies and processes, many portfolio risk managers are leveraging all-in-one Software-as-a-Service (SaaS) solutions for integrated Treasury and Risk Management (TRM) to gain a holistic view on risk and increase commodity price certainty, directly improving company performance and driving shareholder value.