“Normalize: To bring to a normal or standard condition or state.” Oxford Dictionary.
Last article we met John, the head of procurement for Fancy Gizmo. After reading some articles on the Forge aHedge website, John is progressing up the commodity risk maturity ladder.
One day as John is sitting thinking what his next step should be, he’s disturbed by his boss, Sally, the CFO. “Dr Copper”, she affectionately calls him now after he helped smooth out recent market volatility, “I need help.” “Sure,” he says, “what’s up? The copper price?”, and then quickly regretted his joke. “No, one of the directors has given me a riddle and I need your help to solve it. I was explaining the hedges you put in place at the last board meeting, and the director complimented us but asked me about our commodity risk governance processes. “Sally,” he told me, “think Robert Frost, you know ‘good fences make good neighbours’, and we live next door to copper.” Then he got up from the meeting as he had to leave early! Help! What does he mean?”
John smiled, he had just read all about commodity risk governance on the Forge aHedge website. “Easy” he said. “He wants us to draw up a commodity risk management policy. I’ll get something to you today.”
John gets to work. Using the framework from Forge aHedge he starts his policy document but outlining the purpose and scope of the document and the sources of Fancy Gizmo’s exposure to commodity risk. He documents the objectives of the policy and then details who is responsible for the different aspects of the risk management process. Assigning clear responsibility is a critical first step of the risk management process.
With this in place, he next lists the risk measurement process and then sets out the policy compliance limits such as hedge ratios and maximum credit risk the company needs to ensure are not breached. In this section, he also lists the types of permissible hedging instruments. Lastly, he outlines the dealing process including approvals and confirmations to ameliorate any operational risk, documentation required, and finally the reporting necessary for successful administration of the policy.
He emails the Fancy Gizmo Commodity Risk Management policy to Sally with the subject line: “Good hedges make good neighbors”. “And good processes make good risk management” he thinks to himself as he realizes he has just put his first foot on the Normalization rung of the risk maturity ladder.
Let’s Forge aHedge!
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