Deals versus trades

As is evident from the above, the underlying characteristics of energy products are
extremely complex. Electricity customers want to switch on a light and get instantaneous
power from a product that has extremely expensive storage; millions of
customers are doing this by a varying amount minute by minute throughout the
year. Many of the transactions in electricity are designed to back this type of delivery
and are non-standard and complex. On the other hand, the US power marketers are
churning millions of MWhs of standard 5î16 blocks of power. A similar dichotomy
exists in gas and oil.
The energy company risk manager has to be conversant with the two different
‘products’ equally efficiently. The standard product must be able to churn a high
transaction rate without creating significant transaction risk, while the ‘bespoke’
contracts need to be broken down into their risk buckets and assessed individually.
The control process needs to make this distinction early. Standard products or
trades should be closely defined under pre-agreed master agreements, which lead to
‘deals’ failing the authorization tests and thus falling into the deal process. Figure
18.9 sets out a standard trade authorization process for power.
It is important to note that with energy trading it is very easy to put general product
authorizations in place that could be interpreted very widely. For instance, one
description could be US Eastern Interconnect Electricity, but does that include the
sale or ancillary services on the hourly or even minute-by-minute market? Does it
allow knock-out options linked to a foreign currency? Many traders will answer yes,
while the board could answer no.
Product authorizations is an area that is fraught with potential problems as
portfolio authorization becomes more complex. The risk manager has to make sure
everyone has a common understanding of their authorizations and that trader
understanding remains a subset of the board members.

Once you have the product definitions and corresponding legal agreements you
can build a highly efficient trade processing system. The standardization allows for
efficient hand-offs which can give you a much higher degree of specialization in the
business, almost to the point where separate individuals are looking at the different
parts of the chain set out above. To make this work you need to be very specific in
defining the physical product definition (including quality specs), delivery point,
tenure and contract specification. Once it is in place and working you can automate
it and let the IT and IS systems take the strain as transaction volumes increase.
The reporting controls at this stage begin to focus on trade input errors, changed
trades and delivery (or book out) issues. As mentioned above, anything falling outside
this needs to fall into deal analysis. This is identical to trade analysis but many of
the components can occur concurrently, often by a specific deal team that has crossfunctional
skills.
The risk manager’s job with the ‘deal’ is to break it down to the appropriate risk
components, the so-called risk bucketing or risk mapping which becomes key within
energy. This is normally done working closely with the structured products or
marketing desks and will encompass operational, market and credit issues.
With respect to all these issues the operational risk manager is very dependent on
the information systems supporting the trade capture and reporting system.
Extremely close links are needed with the IS department who need to meet the
challenge of developing error-free systems within a rapid application environment.
This is only possible where the IS, operations and trading staff each have a good
appreciation of the requirements and limitations of each other. Again communication
becomes the vital link which is aided by a corporate structure that encourages
common goals and a floor plan that keeps these key individuals within reasonable
proximity of each other.