Executing the Trade: Controlling the Risk

by Peter Seward, Vice President of Product Strategy, Reval

When executing a derivative trade, there are two major considerations a company needs to think about: who they choose as their bank counterparty and how they are satisfying their internal policies regarding derivative trading. The current market environment for corporates entering into derivative hedging transactions is one of uncertainty — not only about the fluctuation in interest rates, currencies and commodity prices, but also about the creditworthiness of banks and even sovereign states. Add to that uncertainty about the regulatory environment, and the external factors for determining which banks to trade derivatives with becomes even more important. Internally, companies must comply with board policies and regulatory requirements, such as Sarbanes-Oxley and the forthcoming rules from OTC derivative reform. When executing a derivative trade, then, only the right system functionality and related processes will enable a company to effectively recognise and respond to changes in the external environment, while ensuring compliance with internal requirements.When a company enters into a relationship with a bank, it is usually for multiple  services, such as short- and long-term financing, brokerage, capital markets, payments, cash management, etc. However, when deciding which bank to deal with for derivative trades, the factors that are most important to consider are: 

• Credit rating
• Price
• Credit lines
• Current and potential exposure with the bank
• Relationship 
• Additional services

When executing a derivitive trade, only the right system functionality and related processes will enable a company to effectively recognise and respond to changes in the external environment, while ensuring compliance with internal requirements.

Before the credit crisis, corporates could concentrate on a few of these (e.g., price, relationship) and ignore the rest without concern. These days, however, timely information on all these factors is critical. By automating the life cycle of the derivative transaction, corporate treasurers, their back offices and treasury accountants can obtain this important information quickly and in a way that provides a valuable audit trail, a structured process for approval and overrides, and a straight-through processing environment for eliminating manual errors. 

Internal factors relate mainly to the specific controls and limits usually written into risk management policies to ensure compliance with board and regulatory requirements. Such requirements result in policies and procedures that traders need to follow to ensure that only approved instruments are traded and only for approved business purposes. These include:

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