Contents - AL-Tax

11.1 Summary of Key Facts 151internal controls. Every physical trade is also generally confirmed in writing withthe counterparty, clearly specifying the terms that the parties intended. Moreover, allcontracts are typically reviewed to ensure that they contain the correct legal clausesand are therefore enforceable, that the terms are correctly stated and accord withthose originally agreed on verbally, etc. Such oversight is critically important totrading firms. Risk managers must also have effective systems and procedures inplace to quantify and continuously monitor different types of risks (market risk,counterparty-related risk, operational risk and liquidity risk). Similarly, an IT systemthat permits risk managers to view transactions and hedges in “real time” is essentialto effective risk management. While certain trading-specific applications softwareis available from third parties, generally by product or sector, it typically requiresextensive customization. 511.1.3.5 Reputation for ReliabilityBroadly speaking, the counterparty-related risks referenced above entail nonpayment(i.e., credit risk), delayed performance (i.e., the delayed delivery ofproduct) or outright non-performance. If the first or third of these eventualitiescomes to pass, the financial downside will generally be enormous. Because suchrisks are so consequential, it is of the utmost importance that trading firms be viewedas reliable counterparties.11.1.4 Recent Developments and Their Effect on the RelativeImportance of Core Assets and SkillsThe core trading elements identified above, including (a) access to financing andproduct, (b) trading, risk management and logistical expertise, (c) effective administrativecontrols, risk management procedures and IT systems, and (d) a reputationfor reliability, taken as a whole, do not change overly much from year to year.However, their relative importance can shift substantially over a comparatively briefperiod. In the past 3–5 years, the commodities trading landscape has been dominatedby four important developments:1. Hedge funds have become a very significant factor in these markets.2. China has diminished dramatically in importance, particularly in the alumina andaluminum markets.3. Pre-payment prospects have dwindled because few producers now requirefinancing.5 For example, energy trading software vendors include OpenLink and Triple Point Technology.Other vendors sell software for natural gas, alumina and aluminum, crude oil and most other tradedcommodities.