Financial risk management

Risk management has become a dominant factor in contemporary markets. As global markets develop and opportunities expand, so does the need for cautious, effective and intelligent risk management.

 

Our highly qualified staff will help you determine whether or how much of your portfolio needs hedging, the potential costs and benefits, as well as which financial instruments to use.

Value - added services for corporates and hedgers

As an established leader in brokerage services, Renesource Capital is consistently developing its product offering, to give its clients an ability to fully hedge any type of financial risk: commodities, pricing, currency and interest rates, while also consulting our clients in the derivatives markets.

In the fast paced world of relentless competition, the ability to identify all the potential risks is of an utmost importance for any company and any commercial activity. Renesource Capital offers a full range of services related to financial markets risks management, including opening a financial instruments account, providing an estimate of hedging efficiency , developiong and implementing a detailed hedging plan.

Without a doubt, the development of a risk strategy is a complex process that involves analysis, choice of instruments traded, development and testing of risk management strategy. This requires special knowledge and experience and, consequently, can lead to extra costs. In this case outsourcing services will dramatically lower the costs, while reducing the risks and potential losses.

To avoid unpredictable losses and to be competitive in the modern business environment, many firms pay considerable attention to hedging, as a part of their risk strategy. In fact, it has been a long standing practice across the world for businesses such as natural resources extraction companies, oil refineries, bunkering companies, airlines, ship-owners, transportation companies and power plants.

It’s essential to find the right broker, that can offer reliable access to the derivatives market. It is worth noting that, as a rule, banks and brokerage companies usually only offer brokerage services, and only in rare cases you can receive a competent price estimate and currency rate risks advice, as well as the opportunity to develop a strategy and choose the best instruments for hedging.

Renesource Capital’s team of derivatives trading experts has the extensive knowledge of international commodity and derivative markets, which enables them to offer clients solutions that are catered directly to their needs.

Renesource capital is well versed in developing of hedging strategies in commodities market, which allows our clients to receive both brokerage services and advice on finding an appropriate hedging strategy.

What is hedging?

Hedging is a way to ensure against financial risks via taking an offsetting position to the one in an asset.

As a result of geopolitical risks and uncertainties in global economic growth, prices fluctuations range on energy markets significantly expands. To protect against the risk of violent prices fluctuations, the practice of commodities hedging using energy derivatives becomes more and more popular. This includes OTC Energy Swaps (the financial instrument used for both speculation and hedging purposes, without intentions of physical delivery).

Using these instruments, the company focuses on the current price of the commodity and secures the commodity against price changes for the specified time period. This how, you can hedge against price increase, decrease, or both.

Why hedge?

  • To fix consistent and stable cash flows
  • To determine/ fix a sale/purchase price of a commodity
  • To reduce the existing cash position risk exposure

Thus locking in a price today allows for better focus on planning and business development with minimum exposure to an unwanted business risk and strengthening of competition.

Basic principles hedging producers with futures contracts

A producer is reliant on the physical (cash) market, where it needs to sell his physical (cash) product. A producer do not know what will be the market price for his physical (cash) product in the future when it will be ready to sell (for example, when the physical product will arrive to the destination point of producer from where it will start selling it). In this case, producer will enter the Futures market by selling Futures contracts thus locking the price in the future.

In case of climbing price, sold futures contracts will generate losses but in the same time physical product will offset those losses on the futures contracts market by selling his product in the Cash market at the higher price.

In case of falling price, sold futures contracts will generate profit but in the same time, physical product will offset those gains on the futures contracts market by selling his product in the Cash market at lower price.

If the price goes down, he makes up for his losses in the cash market by closing out his position in the Futures market.

As a result, the price of the product is fixed and risk of price fluctuations are limited and controllable.

Basic principles hedging producers and consumers physical product price risks with SWAP’s

Producers price risk hedging with selling a swap

  • A swap contract will allow to fix your physical product sales revenues at a predefined level.
  • Fixed sales price, thus making independent of future market movements.
  • Full protection against downward movements.
  • Costs suffered when market increases:
    • When the floating price is below the fixed price Client receives the difference in accordance with the volume of that period
    • When the floating price is above the fixed price, Client pays the difference.

Consumer price risk hedging with buying a swap

  • Fixed supply cost, thus making independent of future market movements.
  • Full protection against upward movements.
  • Cost suffered when market declines:
    • When the floating price is above the fixed price Client receives the difference in accordance with the volume of that period.
    • When the floating price is below the fixed price, Client pays the difference.

To hedge with a swap you need

  • The exact name of the product you want to hedge
  • The reference price such as Platt's or Argus Media
  • The quotation (for example, Barges FOB Rotterdam, Cargoes CIF NWE) which matches your physical product sales contracts.

At the end of each settlement period throughout the life of the swap, the average of the quotation during this period is calculated to determine the realized floating price of the settlement period.

Example:

Let’s consider the case of a company that purchases some raw material (e.g. crude oil or petroleum) in Russia or another CIS country, with intention of selling it in the Baltic States or other countries of Europe. During the processes of finding a buyer and transportation, the price of this material may change in the unfavorable direction. In this case, potential profits may decrease greatly or even turn into losses. To avoid the possibility of such course of events, hedging is an indispensable solution. In this scenario, the company could use sales of futures contracts or OTC Energy Swaps, so that change of the market price during transportation would be compensated by futures contracts or OTC Energy Swaps.

If the market price of commodity decreases, the sold futures contract or ОТС Energy Swap will compensate for the price drop of the commodity.

If the market price of commodity increases, the losses from the sold futures contract or ОТС Energy Swap will be compensated by the price hike of the commodity.

It’s worth noting, that those companies who carry a risk whenever a price of oil increases (autotransporters, large bus parks, ship owners and operators), are the most active users of hedging. In this case they would usually buy a fixed price contract for a certain period of time (1, 3, 6 months, 1 year and so on), which then outlaws the possibility of change in oil price impacting the price of the ticket for their end customer. Overall, airline companies in developed countries hedge 30-60% of the fuel they use.

Renesource Capital, being one of the leading brokerage centers in the Baltic States, persistently develops the spectrum of available instruments, designed to provide solutions for hedging any kinds of risks (commodity risks, price risks, foreign exchange and interest rate risks) and advises its customers on dealing with derivatives.

Renesource Capital activities cover OTC broking of paper swaps, options, collars and zero cost collar option (collar is designed to keep physical product sales within an agreed range), forwards in crude oil and refined products together with exchange broking of energy, agriculture etc. products – futures contracts.

Renesource Capital is one of the major clearers for energy futures products and OTC exchange cleared energy markets in Baltic States with an access to ICE and CME ClearPort and other related exchanges, providing clients DMA to all the major markets.

We also distribute daily technical, fundamental & midday oil and oil product reports which are widely read by the trading community of Renesource Capital.

Renesource Capital has established division, which provides corporates – professional physical traders with advanced execution and clearing services, across all supported markets and asset classes.

Hedging involves the use of market instruments, the most common of which are futures, options and averages.

Renesource Capital team of derivatives trading experts, possessing in-depth knowledge of international commodities and derivatives markets, provides customized solutions to Customers on individual basis.

Renesource Capital has extensive experience developing hedging strategies on commodities markets, which not only allows Customers to use brokerage services, but also to receive assistance in the selection of the necessary strategy for hedging their production.

Hedging of financial risks

Hedging of foreign exchange risks

Foreign exchange risk is the risk of losses because of an unfavorable exchange rate movement. It’s applicable to export and import merchants and foreign currency loans borrowers.

Renesource Capital provides the opportunity to hedge foreign exchange risk using forwards, options and options strategies. The customers have the opportunity to move value dates using swap transactions.

Hedging of interest rates risks

Interest rates risk is the risk of losses because of an unfavorable interest rates movement (for example, Libor or Euribor).

If the company borrows money to finance its activities, it will use derivatives contracts on interest-bearing instruments to hedge against interest rates increase. It’s applicable, in the first place, to companies that borrow at floating rates based on Libor or Euribor.

If the company deposits funds, for example, an insurance company or a financial company that makes loans or credits, it will enter into derivatives contracts to hedge against interest rates decline.

Renesource Capital provides the opportunity to hedge interest rates risk using interest rates swaps, FRA (forward rate agreement) contracts, options and options strategies.

Freight rate hedging

Freight rate fluctuation risk is the risk of losses because of an unfavorable change of a price at which a cargo unit is delivered from one point to another by ship.

Freight hedging works in the same way as a swap (FFA – forward freight agreement). The most common indices are TD3 (tanker dirty Saudi – Japan, VLCC), TD5 (Nigeria – USA, Suezmax), TC2 (tanker clean Rotterdam – USA) and TC5 (tanker clean Ras Tanura – Japan). The other indices are quoted too, but their liquidity is much lower.

Using FFA, ship owners or freight companies that are planning to increase their cargo-handling capacities in the future (for example, by construction of a new ship) can fix the current freight rate.

Hedging strategies

Hedging involves the use of financial instruments, the most common of which are futures, options on futures, CFD’s and paper swaps. Hedging strategy is the combination of the specific hedging instruments and their methods of application to reduce price risks. All hedging strategies are based on the parallel movement of the spot and futures prices, the result of which is the opportunity to compensate on the derivatives market the losses incurred on the commodity market.

There are 2 main types of hedging:

  • Hedge of a buyer (long hedge, input hedge);
  • Hedge of a seller (short hedge, output hedge).

Hedge of a buyer is used when the entrepreneur is planning to purchase a batch of products at some time in the future and he is aiming to decrease risks related to the possibility of its price increase.

Basic methods of hedging the future purchase price of a product involve buying a futures contract, buying a “call” option or selling a “put” option.

Hedge of a seller is used when the entrepreneur is planning to purchase a batch of products at some time in the future and he is aiming to decrease risks related to the possibility of its price increase.

Basic methods of hedging the future purchase price of a product involve buying a futures contract, buying a “call” option or selling a “put” option.

Companies can use a variety of hedging strategies:

  • Full hedging;
  • Selective hedging;
  • Active hedging.

Full hedging: the position opened on the exchange or over-the-counter market is of the same volume and specification, but in the opposite direction with respect to the real commodity. It entirely hedges the risk of unfavorable price movement.

Selective hedging: hedging of the commodity by a similar, but not identical product at the exchange or hedging with the identical product, but not in full amount (leaving part of the commodity volume unhedged). Selective hedging requires constant market analysis and examinations of market trends and, as a consequence, it’s a more risky strategy than full hedging.

Active hedging: decision whether to hedge or not to hedge the specific commodity is made based on the current market situation, forecasts and the personal opinion. This is a very risky strategy.

The importance of hedging as a mean to assure the stable development of a company is very high:

  • It ensures significant reduction of price risk, related to purchases of raw materials and supply of end products; hedging of exchange rates reduces uncertainties of future financial flows and ensures more efficient financial management. As the result, fluctuations of profits get reduced and controllability of manufacturing improves.
  • Well-built hedging program reduces both risk and expenses. Hedging only diverts a tiny fraction of the company funds, allowing executive staff to concentrate on those business aspects where the company has competitive strengths, minimizing side risks. In the long run, hedging increases the company capital by means of lowering funds costs and stabilizing income.
  • Hedging does not overlap with common business transactions and allows to provide steady defense of the price without needs to change the stock reserve policy or to enter into long-term forward contracts.

Risk Disclosure Statement. Margin transactions (Forex, contracts for difference CFD, futures and futures options, stock options, REPO transactions, transactions in over-the-counter derivatives and transactions using broker credit, including selling short) involve higher risk. The level of risk increases with the leverage ratio. As the result of margin transactions, relatively high profits are possible with low level of initial investments, as well as significant losses which may exceed the principal amount of investments or the amount of the collateral. Please ascertain whether margin transactions in their essence and content suit the risk profile that was assigned to you by AS IBS Renesource Capital and whether the content of margin transactions corresponds to your investment goals.