Increasing market volatility.
Mounting competitive pressures.
Changes in policy and regulation.
The pressures on today’s risk managers seem to grow by the day. As a result, the ability to feel confident in mitigating price risk when it comes to commodities or other asset classes may run pretty low from time to time. The pressure can be eased by building a comprehensive hedging and risk management team group within an organization to lead efforts toward proactive risk identification and action recommendation to:
- Defend market share (prevent lost ground to competition)
- Protect margins (maintain profit margins in the face of pricing pressure)
- Secure budgets (achieve a more predictable and profitable future)
- Stabilize pricing (mitigate swings in commodity prices)
- Eliminate surprises (avoid being caught off guard by the unknown)
To build such a team, the following considerations are essential in order to be successful:
- Design a hedging policy. Before starting any work or hiring new talent, first establish boundaries, rules and limits to guide hedging work and objectives. From a top level, a hedging policy should include parameters around the:
- Approved hedging tools
- Max hedging tenor limit, in line with company budget and pricing cycles
- Exception approval process and delineation of responsibilities
- Frequency of portfolio stress testing
- Frequency of risk meetings, and required attendees
- Establish a Risk Committee. This committee should meet regularly and deliberate about positions, results, stress testing, portfolio concentration, sudden changes in market conditions and limits. The committee should be comprised of representatives from commercial, trading, credit, control, and treasury functions.
- Identify and hire the right talent. Like building any team, finding the right talent to do the work is key. A combination of experienced talent from within the organization and individuals from outside the confines of the company can create a complementary and fresh approach. Finding, hiring and keeping top talent with hedging expertise is absolutely key to building an effective program.
- Set up a recurring review schedule. Once a policy and team are in place, the next step is to establish periodic meetings to review exposures, trends, market data, policy, proposals, and exceptions, and to keep everyone aligned. To start, hold these meetings weekly which is widely regarded as a standard industry best practice.
- Define the max concentration of each tool within a hedging portfolio. Every tool within a portfolio needs to have a defined goal of why is it used and how it helps achieve specific objectives–as well as its downside. Define a max concentration limit for each tool to avoid excesses.
- Practice recurring stress testing. Putting the team and company through the paces of different financial scenarios (i.e., “stress testing”) can be extremely valuable. Set a frequency for these stress tests early on and remain disciplined about running these simulations. Share the stress tests and their results at the same weekly risk management committee meetings.
- Schedule annual external audits and benchmarks. It can be beneficial to bring in an independent financial consultant/firm to review results from the prior year, assess risks, and help create benchmarks. It may present an opportunity to identify new risks, benchmarks and facts to refine existing company practices.
- Set strict limits for exception approvals. Create a short list of individuals within the organization who can approve exceptions.
Developing an effective hedging and risk management program and building the team to manage it, does not need to be complicated. The key is to create and maintain balance between different activities, including action, controls and risk identification. The end result should be better risk mitigation and clear, consistent methods for achieving business objectives.