Trading/Hedging Control Environment

Transcription

1 Trading/Hedging Control Environment EEI/AGA Utility Internal Auditor s Training Glen Hecht Partner, Financial Accounting Advisory Services August 24, 2016

2 Agenda Trade Lifecycle Select Risks Select Controls Model Governance Policy Regulatory Compliance/Trade Surveillance 2016 EYGM Limited. Slide 2

3 Trade Lifecycle

4 Assessing inherent risk Inherent risk is its susceptibility to a material misstatement, assuming that there are no related controls Generally, the assessment of inherent risk is high due to the nature of the exposure derivatives present What inherent risk factors would you consider? 2016 EYGM Limited. Slide 4

5 Inherent risk factors assessment considerations Complexity of derivatives OTC vs. exchange-traded derivatives Transactions not involving an exchange of cash Entities previous experience Complexity of valuation Freestanding vs. embedded Interaction with other activities External factors (credit, market, basis, legal risk) Asymmetrical risks (written option) Evolving nature of US GAAP and use of derivatives Volatility Management s objectives 2016 EYGM Limited. Slide 5

6 Assessment of control risk Control risk is the risk that a material misstatement could occur and not be detected or corrected on a timely basis through the internal controls of an entity Obtain an understanding of the internal control environment What types on internal controls would you look for at an energy company? 2016 EYGM Limited. Slide 6

7 Trade Life Cycle Mega Process Deal execution scheduling Transaction support Portfolio support Risk management Settlements Accounting and reporting Front office trade analysis Logistics and scheduling Contract administration Book structure Limit reporting ISO settlements Month close end New product development Hub trade Credit Curve development and management Risk measurements Counterparty settlements Derivative accounting Trading and deal execution Real time trading Deal validation and authorization Valuation Operational risk reporting A/R and A/P Management reporting Major process Deal entry Origination / structuring Price curve development Deal modification Confirmation Collateral / margining Stress testing Pricing validation Transaction reconciliation Broker settlements Physical actualization External reporting Transfer pricing Governance and oversight Support functions: information technology, legal, treasury, tax, internal audit 2016 EYGM Limited. Slide 7

8 Trading and Deal Capture Selected Risks Mega Proces s Deal Execution Traders execute trades with unauthorized counterparties. [Valuation or Measurement, Presentation and Disclosure, Completeness] Front Office Analytics Traders execute unauthorized trades (tenor, volume, portfolio). [Valuation or Measurement, Completeness] Major Process New Product Development Trading Deal Capture Traders execute trades in excess of credit limits. [Valuation or Measurement] Trades are not timely or accurately captured. [Completeness, Valuation or Measurement] Trade amendments are not timely or accurately captured. [Completeness, Valuation or Measurement] Trades are not actualized. [Completeness, Valuation or Measurement] Origination / Structuring Not all trades are captured in the trading system and therefore are not scheduled accurately. [Completeness, Valuation or Measurement] Curve Development 2016 EYGM Limited. Slide 8

9 Trading & Deal Capture Selected controls Mega Proces s Deal Execution Front Office should understand, sign, and comply with the risk policy and all other company policies, including the company code of ethics. Major Process Front Office Analytics New Product Development Trading Deal Capture Front Office should seek approval for participation in new products, markets or services. In addition, Middle Office should provide approval for all new products to ensure that the risk can be measured and monitored appropriately. Front Office should ensure accuracy of transaction terms in the deal capture system (including difference between nominated and confirmed volumes). Documentation outlining standard procedures for conducting business should be developed and maintained. Front Office should conduct a daily strategy meeting to share market information, review positions, and assess strategic direction. Origination / Structuring The Front Office should understand and abide by trading limits, authorized product rules, and restricted activities. Curve Development Front Office phones and electronic forms of executing trades are recorded and archived EYGM Limited. Slide 9

10 Deal Validation / Modification Selected Controls Mega Proces s Transaction Support At end of day, Middle Office should collect the trader s deal tickets or deal logs and verify the deals were entered correctly in the system. Contract Admin Exceptions and violations should be tracked and reported to the Risk Committee. Risk Committee takes appropriate action against traders consistently not entering trades in the deal capture system before end-of-day valuation. Credit Middle Office should validate calculations, market data, and assumptions used to determine costs of operation and liquidity, market and swing risks. Major Process Deal Validation Deal Modification Traders should validate the terms of all new deals each day and submit to the Middle Office. Confirmed or scheduled trades are locked in the deal capture system. If the trade has not been confirmed by end of day, it should be locked down as part of end of day processing. Traders should not have the ability to modify/delete key terms of locked trades. To perform modifications, Traders must request Middle or Back Office personnel to unlock the trade. Modifications should automatically generate confirmations in the system. Confirmation Middle Office should review a Deal Modification report daily to verify that deals are modified per policy. Collateral / Margining Process should be in place to monitor and follow-up on cancellations and modifications of trades coming from one operator EYGM Limited. Slide 10

11 Confirmation Selected Risks Mega Proces s Transaction Support All contracts are not sent and received in a timely manner and independently of Front Office. [Completeness ] Contract Admin Contracts are not reviewed by the Legal department, are not legally binding, contain terms that are not approved/authorized or do not correctly capture the intent of all parties. [Rights and Obligations] Credit Not all trades are obtained by the Confirmations Department for confirmation. [Completeness ] Major Process Deal Validation Deal Modification Confirmation Collateral / Margining Not all trades executed are confirmed or are not confirmed by the Confirmations Department [Completeness ] Confirmations used to validate trade terms by Confirmations Department are not legally binding or contain terms that are not approved/authorized. [Rights and Obligations] Trade is confirmed without an associated contract (i.e. ISDA, NASB, MNA etc. [Rights and Obligations, Completeness] The correct signature authority is not made or is not made in an appropriate time frame. [Valuation or Measurement ] Trade amendments may not be properly confirmed. [Valuation or Measurement ] 2016 EYGM Limited. Slide 11

12 Confirmations Selected Controls Mega Proces s Transaction Support Confirmation group should be independent of the Front Office. Contract Admin Incoming confirmations should be received at a secure fax location (secure from the Front Office). The confirmation template should be approved by the legal department. Credit Confirmation group should review confirmations against trading system, verify compliance with delegation of authority, and fax or confirmations to the counterparty within 24 hours of the trade date or by time specified in the contract. Major Process Deal Validation Deal Modification Once sent, the deal should be locked in the system and should not be modified without proper approvals, the status of the confirmation should be updated in the system to monitor exceptions and ensure completion. Confirmation group should review list of outstanding confirmations daily and follow up on each with the relevant counterparty. Confirmation If a disputed confirmation is received from the counterparty, the Confirmation group should notify Front Office and the counterparty within 24 hours of receipt to make all parties aware of the discrepancy while the appropriate personnel can reconcile the issue. Collateral / Margining Formal and regular reporting of confirmation metrics (e.g., unconfirmed trades, aging) should be reported to groups outside of Operations/Middle Office (e.g., Legal, Compliance, Credit) EYGM Limited. Slide 12

13 Counterparty Settlement Selected Risks Margin requirements are not calculated. [Completeness] Mega Proces s Settlements Trade amendments are not captured accurately and in a timely way [Valuation or Measurement] ISO Settlements System/Spreadsheet does not contain all transaction [Completeness or Existence] Major Process Counterparty Settlements A/R & A/P Broker / Exchange Settlements All deals within the deal capture system/spreadsheet to be invoiced are not invoiced. [Completeness] Transactional information within invoice is inaccurate or incomplete. [Completeness; Valuation or Measurement] Invoices are not properly netted when netting agreements are in place. [Valuation or Measurement] Duplicate invoices are recorded in the subledger. [Existence or Occurrence] Invoice in subledger is missing, incomplete, inaccurate, not properly supported, not posted, posted to the wrong period, or not authorized. [Completeness; Valuation or Measurement; Existence] Invoices are not sent or received by the Accounting department. [Completeness or Existence] Trade amendments are not captured accurately or in a timely manner. [Valuation or Measurement; Existence or Occurrence] 2016 EYGM Limited. Slide 13

14 Counterparty Settlements Selected Controls Mega Proces s Settlements ISO Settlements Counterparty Settlements Standard settlement and delivery instructions should be established for all counterparties. This includes setting up proper controls for establishing and authorizing instructions, for changing previously approved instructions, for structured transactions and for nonstandard deals. Back Office should monitor receipts and payments of balances due and immediately notify appropriate credit management personnel, trading personnel, and/or originators responsible for executing the transaction of material past-due payments or underpayments. Major Process A/R & A/P Broker / Exchange Settlements Approved authorized limits for payments prior to disbursement should be defined and documented. Settlement, disbursement, and trade processing functions should be independent of each other. Payment values should be automatically calculated based on trade data entered into a designated transaction management system. Access to the payment system should be secured and restricted. Automated pre-settlement reconciliation of invoices with counterparties should occur. A monitoring process should be in place to identify false counterparties in the AR and AP process EYGM Limited. Slide 14

15 Month End Close Selected Risks Mega Proces s Financial Accounting Month End Close Derivative Accounting Data is incomplete or inaccurate. [Completeness, Occurrence] Reversing journal entries are not reversed in correct accounting month or are not reversed. [Completeness, Occurrence] Journal entry is missing, incomplete, inaccurate, not properly supported, not posted, posted to wrong period or not authorized (incorrect account string, typographical error, Excel function error, etc.). [Occurrence, Completeness, Valuation & Measurement] Major Process Management Reporting Financial statements are incomplete or inaccurate. [Occurrence or Completeness] Manual journal entry is prepared twice in system or prepared twice under two JE numbers. [Occurrence, Completeness] System or manually entered journal entry is posted twice in the system. [Occurrence, Completeness] 2016 EYGM Limited. Slide 15

16 Month End Close Selected Controls Mega Proces s Financial Accounting Month End Close Reconciliation of the general ledger and trading system. A Monthly Team report should be provided to management on a timely basis and prepared in accordance with policies and procedures. General Accounting should be independent from Trading, Settlements, and Treasury. Major Process Derivative Accounting Management Reporting Month-end close procedures should be developed for all risk books. Close process includes verification with appropriate groups that month end results are complete and accurate (i.e., actual volumes, change ship dates, index prices, accrual updates, etc.) Appropriate data is reported under the respective business unit. Intercompany and inter-book transactions should be identified and appropriate journal entries booked to the general ledger. P&L valuation is appropriately aggregated and updated in price risk management accounts EYGM Limited. Slide 16

17 Derivative Accounting Selected Controls Mega Proce ss Financial Accounting Month End Close Proper accounting rules and regulations should be followed (e.g., ASC 815 and ASC 820). Derivative Accounting policy should discuss cash flow vs. fair value hedge designations, hedge documentation requirements, and acceptable methods to test hedge effectiveness and calculate hedge ineffectiveness. Analysis and calculations should be documented and retained as an audit trail. Derivative Accounting Appropriate audit procedures should be performed by both internal and external auditors at least once a year. Major Process Management Reporting Changes in accounting methods, measurement techniques and estimates should be properly disclosed. All contracts should be assessed to determine that they meet requirements to be considered a derivative contract. Derivative Accounting should perform a daily review of non-standard transactions. At least quarterly, Derivative Accounting should perform a retrospective hedge effectiveness regression analysis to determine if hedges fall within the acceptable range of hedge effectiveness. Derivative accounting journal entries should be booked on a timely basis in the general ledger and a report should be generated EYGM Limited. Slide 17

18 Risk Management Selected Risks Mega Proces s Risk Management All positions are not obtained for price validation. [Completeness] Broker quotes are not available for all positions. [Completeness] Major Process Limit Reporting Risk Measurement Operational Risk Reporting Price Validation Traders' marks are not validated. [Valuation or Measurement] Curve updates are not accurate or are not reflected in the final P&L run. [Valuation or Measurement ] Models used in the valuation of transactions are not accurate due to incorrect/unapproved changes. [Valuation or Measurement] Not all positions are captured for review. [Completeness] Positions are not monitored against established limits. [Completeness] Violations are not reported. [Completeness] Credit limits are not properly assigned, calculated or approved for new counterparties. [Valuation or Measurement] Credit lines are not established for all counterparties. [Completeness] 2016 EYGM Limited. Slide 18

19 Risk Management Selected Controls Mega Proces s Risk Management Is there a model Governance Policy? Is there an independent process to evaluate profitability/exposure to trades? Limit Reporting Is profit and loss calculation performed centrally? (i.e., decentralization of books and positions does not provide an accurate, timely view of portfolio profit and loss) Major Process Risk Measurement Operational Risk Reporting Price Validation Is profit and loss calculated on a net or gross basis? (i.e., net profit and loss is not understating gross positions) Does the process consider embedded optionality? Is there a formal process for assessing cash contract risk? How are trading limits set/enforced? How often are limits breached? What were the circumstances? VaR limits should be breached periodically; if not, VaR is set too high and may not be an effective risk mitigation-tool Volumetric limits should not be breached without prior authorization What are the escalation/reporting protocols for limit violations? How is the running exposure (market, counterparty, liquidity, etc.) to the trading book monitored? 2016 EYGM Limited. Slide 19

20 Model Governance Policy

21 Model Governance Policy Companies rely on models extensively to support important business activities, e.g. To inform decision-making To monitor and manage risks To forecast operational or economic results Models provide valuable insights because (unlike people) they are Logical and objective Systematic and consistent Capable of complex and/or complicated computations Models introduce risks because they may be Invalid due to flaws in the input, processor or report components Inappropriate due to uninformed or improper selection Incorrect due to erroneous, misjudged or misinterpreted usage 2016 EYGM Limited. Slide 21

22 Regulatory Compliance/Trade Surveillance

23 Complex Regulatory Universe There are multiple regulators and the rules are often intentionally broad Manipulation rules are often crafted to cover unspecified future actions Commodity Exchange Act Broad sweeping prohibition against manipulation Provision for manipulation by false reporting and false information ISOs ISO rules Delegated from FERC Spin out market monitoring function Dodd-Frank Act Governs financial & commodity markets Anti-fraud & anti-manipulation provisions Business conduct standards Position Limits Whistleblower Incentives CFTC SEC Commodity Markets Participant FERC Commodity Exchanges Energy Policy Act (2005) Governs trade of power / transmission, natural gas / transportation markets Amends Natural Gas Act & Federal Power Act to prohibit manipulation MiFID, CRD, REMIT (European Commission) Markets in Financial Instruments Directive (MiFID) Capital Requirements Directive (CRD) Regulation on Energy Market Integrity and Transparency (REMIT) Foreign Regulators Exchange Rules CME, CBOT, NYMEX, ICE, SMX rule books Conducts daily trade, position, account and user surveillance Monitors and reviews the accuracy of audit trail data 2016 EYGM Limited. Slide 23

24 Trade compliance Compliance covers a broader area: Market manipulation is only the most visible top of mind issue for the market participants The market operators focus as carefully on the operational rules Trade Compliance covers the entire breadth of areas regulators and their delegates can investigate and enforce Trade surveillance Market abuse Market manipulation SEF/exchange/physical regulator Cross national/national/sub jurisdiction regulators Futures markets Exchange rules Position limits Exchange operator regulations Cross national/national/sub jurisdiction regulators Derivatives regulations Swaps market compliance SEF regulations Cross national/national/sub jurisdiction regulators Trade compliance Physical markets Execution rules Capacity rules Market operator regulation Cross national/national/sub jurisdiction regulators 2016 EYGM Limited. Slide 24