CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

28.6 MITIGATING OPERATIONAL RISKS

Often, firms that have lost money attribute their losses to lax operational controls. One area that is particularly prone to operations mistakes is the accurate setting of energy commodity attributes. There are thousands of energy commodities (defined by physical market product or location), most of which have unique settlement mechanisms, holiday calendars, and OTC averaging conventions. Due to the sheer number of variables at play, transaction risk materially increases. To mitigate this risk, a firm needs an auditable process of trade recording. This process should include reconciliation with the primary broker and OTC confirmations. Trade recording and confirmations or reconciliations should be performed by different people within an organization to ensure objectivity and serve a gatekeeping function. All amendments to trades must also be recorded and documented. Therefore, Microsoft Excel is not an adequate risk-management system. A risk-management process needs to include an auditable risk-management reporting system into which all trades are entered. Any separation of the trade entry and confirmation process may cause the firm to misreport its risk and net asset values to stakeholders.