Commodities are one of the fastest growing markets. Commodities market solutions can no longer be an add-on or secondary offering. The IT infrastructure involved in trading is an important aspect of the market that is often overlooked, according to a new report, ‘IT Solutions for Trading and Risk Management in Commodity Markets’ from Celent. The main findings of the report are as follows:
- Commodities investments comprise up to 10% of many large investors’ portfolios. The nature of related IT offerings should correspond to this. The number of exchange-traded products has gone up significantly in the last few years, and the high degree of innovation on the financial side of the commodities market has been mirrored by an increase in sophistication on the operational and technological ends. However, there is still progress to be made. Technology vendors in this space are often reacting to the situation rather than taking advantage of it.
- Automation has reduced trading costs and transformed the structure of commodities markets. The effects have been crucial: the cost of trading has declined significantly and the means of delivery to investors has changed radically. Nevertheless, an important and often overlooked aspect of many participants’ success in the commodities market is the operational infrastructure that was put in place when the firm began operating in the domain.
- Structural changes facilitating the commodity markets include: increased corporate hedging sophistication; growing investor interest in commodities as a diversifying asset class as well as an area of growth; improved supply-side sales and trading efficiency; structural growth in financial intermediation in key commodities markets (EU Power and Gas, emerging oil markets, softs, etc.); investment bank and institutional investment in commodities assets for private equity and trading purposes; and Enron’s demise.
- High volatility in the markets is making the management of risk a crucial task. There is a need for more advanced and diverse trading and risk management solutions that cater to the deepening of the sector. Given current economic turmoil, strong risk management is essential. Controls need to be developed and maintained to monitor behaviors that could damage corporate profitability and reputation. The development of tools that help users keep abreast of the impact that high market volatility is having on their portfolios on a daily basis is also important.
- Investors entering the industry must conduct due diligence regarding the firms and funds they would like to invest in before moving forward. The success of a seller in the commodities market is increasingly dependent on the level of automation and how well it has adapted to the changing structural scenario of the market.
- The large number of derivatives products available means that the back office often struggles to cope with the requirements of trading. An increasing number of players means that the market’s main players have to work with a larger number of counterparties than ever before, making risk more difficult to manage.
- Cross-product functionality is important. Products often concentrate on just a specific sub-segment of the market (energy, metals etc.). In the rapidly developing market, banks, corporates and institutional traders might want to dabble across commodity groups. Cross-product functionality along with integration with foreign exchange products, real time data and simulation, and the backing of a module handling the accounting compliance are essential components in creating a sophisticated solution.