Commodity Trading & Risk Management
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Process Spaghetti

What causes consistent margin leakage and sometimes catastrophic loss in commodity supply chain and trading businesses?  
Where can one find the best return on investment? 

Origin to destination flow of bulk commodities is a thin margin business. What can be gained through good positioning, tight logistics and reliable customers can be destroyed very rapidly through poor internal process and lax risk management.

I have lost count of the number of times I have seen margins wiped out due to poorly hedged forex exposure, unauthorised contractual add-ons, poor execution errors, lack of limit enforcement and inefficient administrative procedures. All of these errors are common and yet unnecessary.  

As businesses grow and volumes expand the commercial imperative often exceeds the ability of administration and risk process to deal with increasing workloads. There is always less incentive to invest in cost centres than to invest in the commercial, sales and trading departments of the business. The assumption and expectation is that the mid and back office functions will ask for budget when they can need it. By the time they need it, it’s often too late.

Analysing the trade initiation to financial reporting process, ideally by following a few individual transactions all the way through the trade lifecycle it becomes clear when process has, over time, become inefficient. As businesses expand the product mix, volumes and new administrative requirements increase. Often new tasks are farmed out to a department or persons that were not necessarily best positioned to do that task in any volume. Over months and years with multiple changes this can lead to very convoluted and complex administrative processes being integrated into a current way of working. The inefficiency of this is usually opaque to those involved as they have “always done it this way” and it is clear who is doing what tasks and as an individual, from where information arrives on the desk and where or to whom it departs. The process as a whole becomes a complex spaghetti which is difficult to modify and slow to change without effecting the daily operation of the business. Over time it also leads to a break down in communication between different parts of the process and when problems in one part of the process occur there can be finger pointing and undue stress on the department perceived to be holding things up. In an active supply chain, a delay in any part of the process is not a departmental problem but a problem for the entire business.

The key is to reduce complexity. It is so often the case that when faced with high and increasing workload, rather than focus on simplifying process, there are calls for the development and implementation of new contract management, risk and finance systems. Experience suggests that trying to implement anything on top of already complex processes leads to failure in time, resources and expenditure. When looking to implement a new system business analysts are sent in to translate the current ways of working into a specification for the system builders. A major issue arrises when those processes the business analysts are defining are overly complex. I have learnt that the first essential step is not to look for a new system but to find people who are expert at simplifying process and put them together with subject matter experts. Once processes have been simplified a system has a far better chance of being implemented successfully.

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