Rethinking risk: the role of XVA in commodity markets

Commodity trading firms face heightened complexity amidst volatility in today's market. Holistic credit risk management is crucial and firms have been prompted to reassess practices to navigate risks effectively.

Against a backdrop of price volatility, cost pressures, compliance, and competition, managing a commodity trading firm in today’s landscape is far more complex than it has been before. Despite this, many firms are still relying on traditional, manually intensive methods to evaluate and respond to risk.

Counterparty risk is the biggest risk faced by commodity firms, primarily due to the complexity in hedging it. This risk can be categorised into settlement risk and pre-settlement risk. Settlement risk can be hedged by insurance.

Pre-settlement risk on open contracts is largely managed by establishing limits and monitoring of exposures such as Mark-to-Market (MTM) and Potential Future Exposure (PFE) against those limits. Until recently, there has not been a systematic effort to quantify this risk using measures like Credit Valuation Adjustment (CVA). However, there is a shift underway, with some firms, particularly those in the energy sector, looking to adopt CVA and other Valuation Adjustments (VAs) under the XVA framework from financial markets for pricing and valuing commodity trades.

Commodity firms have begun systematically pricing XVA on their portfolios. Emulating best practices from financial markets, early adopters of XVA, offers valuable insights for effective implementation. For commodity players without existing XVA systems, they have the option to either purchase a third-party solution or develop one internally.

Contents

  • Counterparty risk and XVA complexity
  • Bridging the gap: adopting XVA
  • Pricing complexity of commodity instruments
  • Wrong-way risk and devaluation
  • Implementing XVA in commodity risk management

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Multinational commodity firm selects Quantifi for XVA trading & counterparty risk management

The client is a leading market maker specialising in energy and metals derivatives that provides comprehensive coverage across physical commodities, listed derivatives and OTC derivatives in oil, gas, power, emissions and metals.

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Commodity Markets: Managing Risk During Times of Volatility

This paper examines the distinctive challenges in risk management that commodity trading firms face and how they are responding to such risks to endure market disruptions.

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COFCO International Selects Quantifi to Support Global Commodities Operations

COFCO International is the overseas agriculture business platform for COFCO Corporation, China's largest food and agriculture company. COFCO International is focused on being a leader in the global grains, oilseeds and sugar supply chains, with assets across the Americas, Europe and Asia-Pacific. COFCO International trades with more than 50 nations, handling over 100 million tonnes of related commodities with revenues of $31bn (figures from 2019).

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