Issue: Apr 2015


Why the automotive industry needs to shift gears to make risk management a success



by Premvir Jain, Head of Metals at OpenLink

The automotive industry is in the midst of a significant change as major players across the industry are experiencing high levels of exposure to the metals market. 

 

From cabling to construction, aeroplanes to automobiles, any firm exposed to metals is affected by this trading revolution – driven by high levels of volatility and complexity. But particularly affected is the plethora of automotive firms exposed to metals – for whom access to the physical product is at the heart of their business. It is clear that success requires a serious rethink of risk management. 

 

The metals market is a very different place to what it was five years ago. Take price volatility, which has triggered a shift to shorter contract terms – suppliers are reticent to tie themselves into long term agreements, and automotive firms need to be able to take advantage of falling prices. Gone are the days of major car brands signing five-year agreements with a manufacturing company to receive their critical raw materials. Today, big firms are faced with a maximum of 6 or 12 month contracts. While this brings flexibility, it also increases counterparty, credit, volume and operational risk.

 

If this wasn’t enough, we have seen a rise in market complexity, largely driven by the growth in the financial trading of metals and the surge in popularity of exchange traded funds (ETFs). An ETF is simply a stock that tracks an index such as the FTSE, and changes in price throughout the trading day depending on how the index is performing.

 

Then you have the small fact that the metals market is now a source of investment and volatility, no longer a predictable outcome of supply and demand imbalance, and is affected by macroeconomic events. Nowhere is this more evident than in China. Last year, shares in China's steelmakers accelerated ahead of international rivals such as Russia providing buyers with cheaper prices, triggering renewed demand and a significant effect on the price of steel. For any automotive firm, this introduces yet another layer of complexity to risk management in terms of ensuring the right supplies are selected. This also adds a layer of logistical complexity. 

 

The result is clear: a more complex market with higher levels of volatility equals greater potential risks. For automotive businesses to avoid veering off road, they must shore up their approach to risk management by ensuring they have the right trading and risk management systems in place. Any system needs to cover both physical and financial contracts, so an automotive firm can get a fully aggregated view of positions and risk, as well as potential profit and loss. After all, no firm wants to run unnecessary risks by staying rooted to the same old systems. 



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