Presentation on theme: "Page 1 Peter Nessler, President FCStone, LLC USDA 2011 Agricultural Outlook Forum February 24-25, 2011 A Brokerage Firm’s Approach to Risk Management International."— Presentation transcript:
Page 1 Peter Nessler, President FCStone, LLC USDA 2011 Agricultural Outlook Forum February 24-25, 2011 A Brokerage Firm’s Approach to Risk Management International Assets Holding Corporation | www.intlassets.com
Page 2 The INTL FCStone Business Model Mission: To reduce commodity price risk exposure while improving bottom line results for our customers
Page 3 Offices Where we do business 27 offices | 800 employees | 10,000 customers in more than 100 countries Our Global Presence
Page 4 Specific Commodity Product Risks Covered by INTL FCStone Energy –Natural Gas –Crude Oil –Heating Oil –Refined Fuels –Propane –Marine/Bunker Fuel Renewable fuels –Ethanol –Bio-diesel Weather Derivatives –Volumetric Risk Foreign Currency Exchange –Spot –NDFs –Forwards Financial Instruments Interest rate Carbon Credits Forest Products Precious and Base Metals Freight Index Rates Agricultural –Corn –Wheat –Soybeans, Soybean meal/oil –Cotton –Sugar –Rice –Cocoa –Fertilizer –Rapeseed –Palm Oil Livestock and Meats –Live Cattle –Beef –Pork –Poultry Dairy and Food –Milk, NFDM –Butter –Cheese –Specific cuts of beef / pork
Page 5 FULL SERVICE RISK MANAGEMENT INTL FCStone’s Approach to Customer Risk Management
Page 6 Risk Management Plan Goals & Objectives Data Analysis Industry Intelligence Execution & Hedging Year End Report Month End Report IRMP Process
Page 7 The Current Commodity Price Risk Management Environment Historic Volatility and Greater Systemic Risk
Page 8 The Trend in Overall Commodity Price Volatility
Page 9 Recent Volatility Primarily in the Energy Sector but Historically High in All Commodities
Page 10 Increased Commodity Price Volatility Provides Challenges and Opportunities for a Futures Commission Merchant (FCM) The market price swing in 2008-2009 was unprecedented in its scope and magnitude, and created extreme conditions that tested everyone in the marketplace. The increase in price volatility created greater risks in the credit and counterparty performance areas. The exchange traded futures margin system has performed exceptionally well over the past 150 years but the fast moving markets of 2008/09 created exceptional strains on the system, but it held up pretty well. The market environment also created extreme stress in the over-the- counter (OTC) marketplace with substantial increases in credit insurance premiums and the increased scrutiny of the credit default swaps markets in the aftermath of the home mortgage meltdown. Most FCMs were able to survive the extreme market conditions and valuable lessons were learned and incorporated. A side benefit of the extreme price volatility, from an FCM perspective, was that it emphasized the importance of a sound price risk management strategy for those who do business in commodities. INTL FCStone was well positioned to take advantage of this renewed interest in risk management planning with our structured IRMP approach.
Page 11 Commodity Price Risk Has Become More Systemic over the Past Decade
Page 12 Increase in Systemic Commodity Price Risk Reduces Opportunities to Use the Traditional Approach of Diversifying Away Price Risk Traditional diversification has become less effective as a price risk management strategy in the past decade. Farmers can no longer offset some of their price risk by taking on additional crop and livestock enterprises. Commodity processors and other users can no longer enjoy the benefit of “natural hedges” between some of their ingredient costs. Creates another opportunity for FCM firms as the most effective remaining price risk management strategy is to contractually transfer the risk through hedging markets.
Page 13 The Additional Risks Faced by the Modern Futures Commission Merchant (FCM)
Page 14 Besides Market Risk, FCM’s Face Risks in 8 Additional Areas Credit Risk –Corporate Leverage –Customers –Counter Parties –Exchanges Operational Risk –Execution –Trade System –Order Entry –Platforms –Settlement –Performance Legal Risk –Corporate –Legal –Moral –Ethical Responsibility Litigation Risk –Risk to Defend –Risk to Pursue Liquidity Risk –Inability to Offset Positions –Inadequate Cash Reserves to Meet Contingent Liabilities Regulatory Risk –NFA –CFTC –SEC –IRS Human Resource Risk –Capable, Reliable, Honest and Ethical Staff –Management –Governance Political Risk –Policy Change –Governance
Page 15 Credit Risk Management Strategies Have a well-defined systematic approach to establishing well- defined customer credit limits. –Make use of modern credit scoring / rating methodologies. –Require detailed financial information from potential clients. –Make use of credit value-at-risk (VaR) methodologies. Make good use of the consultant’s relationship to the client. –Educate consultants on how to collect financial information from clients and how to spot potential credit problems and red flags. –Make sure that the consultant shares in the responsibility of client credit monitoring and remedial actions. For over-the-counter (OTC) markets: –Mark positions to market daily and provide daily statements to customers. –Make good use of counterparty insurance and credit default swaps to insure established counterparties. Invest in new technologies that improve the ability to monitor customer balance situation on a real time basis.
Page 16 Operational Risk Management Strategies Invest in new electronic technologies. Invest in good database feeds and sources. Invest in top-notch IT personnel. Get feedback from risk management consultants and clients regarding system performance. Have well-established policies and procedures for handing trades. Have a strong training program for risk management consultants. Have a company disaster plan in place.
Page 17 Legal Risk Management Strategies Always require sufficient documentation. –Make sure that all contract templates conform to state and industry standards. –Make sure that adequate recording devices are in place at all offices that are involved in taking orders. –Educate risk management consultants on maintaining adequate documentation on trades. Make sure that sufficient authority is established and communicate to all employees and clients. –Who can sign contracts. –Contract review procedures. Remove or minimize the areas of legal uncertainty. Hire good legal staff.
Page 18 Litigation Risk Management Strategies Establish a companywide code of professional conduct that is based upon industry best practices and the highest ethical standards. Conduct due diligence in reviewing companywide practices. Have system in place to monitor compliance with policies. Have regular compliance department review of sales and trading operations.
Page 19 Liquidity Risk Management Strategies Have strong cash management practices in place. –Have a good system in place for forecasting / anticipating potential calls upon cash reserves. –Utilize value-at-risk (VaR) models to establish conservative cash reserve requirements for contingent calls and regularly stress- test the system. Have firm definition of what constitutes an illiquid market. –Volume / open interest? –Average bid/ask spread? –Complexity of unwinding the position? Take market liquidity into consideration when assessing risk. –Establish conservative timeline for unwinding illiquid market positions when calculating VaR and other risk measures. –For larger positions in illiquid markets, have an established liquidation plan in place.
Page 20 Regulatory Risk Management Strategies Establish a strong compliance department. Make sure that senior management actively supports company compliance department and policies. Regular communication with regulatory agencies and exchange compliance departments. Strong risk management consultant education programs.
Page 21 Personnel Risk Management Strategies –Maintain careful screening and hiring of new employees. –Establish strong training programs for new and established employees. –Have written policies and procedures, and make sure that each employee has received and understands. –Maintain a regular and ongoing review process between supervisors and employees. –Build firewalls between various employee groups where necessary. –Maintain proper staffing levels in key departmental areas. –Maintain consistent execution of controls. –Facilitate communication between offices and employees. –Provide each employee with the resources needed to do the job.
Page 22 Summary The past five years have been exciting and challenging times for Futures Commission Merchant Firms. Extreme commodity price volatility and greater systemic risk have made the role of the FCM more important that it has ever been in meeting the risk management needs of producers and agribusinesses. INTL FCStone has taken a unique approach to the commodity risk management business through its Integrated Risk Management Program (IRMP) which provides a structured approach to assessing and managing our client’s price risk. Besides the obvious risks related to the markets, an FCM faces a wide array of risks in other categories. The recent market volatility has brought credit risk management to the forefront.
Page 23 World Grain Stocks have declined 60 mmt this year World All Grain Demand grows 40 mmt per year