energy trading risk management - Oil & Gas Financial Journal

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timings outlined below. This view on CTRM vendor evolution is based on similar regulatory regime changes related to Sarbanes- Oxley (SOX), derivative accounting (FAS 133/ASC 815), and even more recent issues related to gas price reporting and “Shipper Must Have Title” . System capabilities for Dodd-Frank compliance over the next five years will likely progress from Ad-Hoc, to Fragmented, and then Comprehensive and Integrated. As the rules related to swap transacting, including issues like position limits, end-use exception, etc., have not yet been finalized by the CFTC, energy companies’ response will similarly progress from stages that can be characterized as “Wait and See,” to “Maintain Awareness,” and then to “Proactively” addressing the combined business and technology solutions to meet compliance. Ad-Hoc While a small number of energy market participants are beginning to address their expected Dodd-Frank requirements, the majority of companies have been slow to make investment decisions regarding changes to their underlying CTRM systems and processes, given the high degree of uncertainty with respect to the final rules. Unlike the FSI industry, which has historically been more heavily regulated and is used to proactively responding to regulatory ambiguity, many energy companies have difficulty making investments or major decisions to address these issues until they become better understood. Similarly, CTRM vendors are unlikely to build functionality that addresses Dodd-Frank in any comprehensive manner thereby putting the burden on energy companies to develop internal ad-hoc solutions to meet their needs. As in the past with SOX and derivative accounting requirements, the initial response to be in compliance with Dodd-Frank for most companies will be to develop interim solutions using Microsoft Excel. Similarly, the related business processes will likely be highly manual and ad-hoc. In this environment, the challenge to build out these ad-hoc tools will be three-fold. First, from a data perspective, organizations will need to capture information not currently available in existing systems. Examples of this would include Dodd-Frank counterparty classification, obligation security method, and counterparty end-use exception election, as well as new internal deal classifications. There will also be an element of data cleansing so that the reported data is accurate. Companies that have transacting and counterparty information in numerous systems will have an especially large challenge with integrating and standardizing their data to meet these initial reporting requirements. Dodd-Frank reporting requirements will not only impact energy companies’ trading functions but also likely the fuel procurement, treasury and regulated hedging functions. Therefore, these ad-hoc solutions and processes will impact a large number of personnel. Second, the data must be combined and transformed to correspond to Dodd-Frank reporting standards. Positions will need to be aggregated and classified, and new reporting views need to be developed which in many cases are currently not produced by companies today, and lack relevant business processes and controls. Third, mechanisms for internal as well as external distribution need to be developed. This includes the governance, responsibility, and accountability for approving information. This will include approval of some reports by the board and senior executives as defined by the CFTC. The standards that companies would likely apply to these reports will be similar to those required for external financial reporting. Internally, position limits, counterparty exposure, collateral, and trading behavior consistent with classification will need to be actively monitored and reported on. The standards that companies would likely apply to these reports will be similar to those required for normal operational reporting. Early on, for most companies that have not gone through Dodd- Frank preparatory projects, the focus will be on rapidly responding to the new requirements and will not be on developing sustainable processes and compensating controls. Given the high bar of complying with Dodd-Frank, companies cannot afford to stop there. This will lead them into the next stage of maturity. Fragmented In the short to medium term, Dodd-Frank rules will continue to be refined. Energy companies will need to work towards not only enhancing and automating their previously constructed tools and processes, but also towards integrating these into their commercial and regulatory reporting organizations. Dodd-Frank regulations will not stop at requiring merely periodic passive reporting. They will reach deeply into the business and will require an extremely high level of internal communication. For example, managing a counterparty’s Dodd-Frank designation will be an on-going process. Further, companies that are able to proactively integrate Dodd-Frank requirements into their trading strategies will likely have a competitive advantage. At this stage it is unlikely that off-the-shelf solutions, from specialized niche vendors or traditional CTRM vendors, will be available. Therefore, energy companies will need to enhance their previously developed ad-hoc processes and tools for sustainability while incorporating a higher degree of automation and workflow capabilities. These tools and processes will be more closely integrated into the commercial organizations and, as learning is internalized, a set of industry best practices will be developed. Excel-based tools will give way to data repositories that are integrated and linked to existing CTRM solutions and other business systems. New data capture will be automated to a greater extent than before. Finally, commercial decisions will be strongly influenced be the Dodd-Frank reporting process. Energy companies will now be transitioning out of passively responding to an externally imposed reporting requirement, and into a stage where Dodd-Frank is becoming ingrained in their business. At the conclusion of this stage, a small number of niche vendors that have built custom solutions for energy companies for Dodd-Frank compliance tools may emerge. Comprehensive In the medium term, we expect that Dodd-Frank compliance 32 Energy Trading & Risk Management ◆ November 2011 ◆ www.ogfj.com
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