Commodity risk management operations in India are not fully geared to protect margins due to the lack of focused and structured hedging programmes within companies, Ernst & Young (E&Y) found in its maiden survey of 45 large- and mid-size firms across the country.
The survey points out that hedging programmes undertaken by companies in India are still generally short-sighted, driven to a large extent by market views and not always aligned with the risk philosophy of companies. Though firms understand the need for hedging and instruments available, the finer aspects of hedging such as basis risk and timing risk, which can significantly affect hedge cash flows, are often ignored.
The survey captures views of companies across sectors, which have exposure to a wide range of commodities including non-ferrous metals, oil and petroleum products, precious metals, agro and soft commodities. It also assesses views of companies across the value chain including producers, processors and end-users.
According to the survey, more than 50 per cent of firms saw hedging as a tool to lock-in input costs at a target level.
Interestingly, more than 68 per cent of the respondents comprising company senior representatives had a hedging horizon of less than three months indicating that the full potential of hedging to protect long-term business cash flows was not being explored.
E&Y, which engaged in building risk management capabilities among participants of commodity trading eco-systems, found that the availability of standardised exchange-traded products remained prominent in the list of hedging products of most firms. Relatively simpler instruments such as forward and futures were used by more than 92 per cent of the respondents indicating that customised hedging instruments are yet to gain ground.
Governance of commodity price risk management function is critical to ensure that risk management activities are always consistent with the risk philosophy and risk appetite of the company.
Commodity hedgers need to improve management skills through elite manpower with adequate knowledge of both financial and commodities markets, said Farrokh Tarapore, partner, E&Y.
Commodity price risk management in the country is at various levels of maturity, depending on the commodity and where the player is positioned in the value chain. The general attitude towards extracting value from this function has, however, been lacklustre.
“Unprecedented volatility in commodity markets has threatened structured margins in fundamentals businesses like never before. For the first time price risk management is being seen as an all pervasive function touching every aspect of the business cycle. Commodity price risk management is no longer limited to hedging,” said Hemal Shah, Associate director.
