Where Price Risk Management Policy Goes Off Track

In Formula 1 racing the activity of the pit crew can be as exciting as the race itself. During a stop, the calculated precision of a good crew’s actions, tweaking the engine, adjusting body parts and changing the tires in just seconds can make the job seem effortless. The truth is however that the speed and ease with which they work is not just the result of mechanical ability and personal dedication of crew members. Core to their success is an accepted and focussed understanding of a common goal and the crew’s own rules of engagement. Successful businesses require nothing less, and a pillar of that focus is the presence of a carefully crafted policy for each major functional unit. Commodity price risk management activity is no exception to this rule.

Business policies and their components require no explanation; they include the why’s, what’s, when’s and how’s that will govern the inner clockwork of the business. The same applies for price risk management but it’s often here that first major errors are made, sending the price risk management programs off the track. One reason is that policies are generally a reflection of the collective experience of senior management and the board. Senior people who set them have typically earned their places through years of production, commercial, legal and accounting experience but in these disciplines the concept of price risk management is alien. Their lack of familiarity with required structures, and oftentimes their aversion to previously unknown risks highlighted by price risk management, gets reflected in the price risk policy. The result can be race strategy orders that themselves cause conflict with the goals of other departments or a degree of risk aversion that is clearly undesirable or even impossible to achieve. A stated policy of “zero price risk”, frequently senior management’s self-protecting declaration to the troops, is a cop-out. Senior management needs to accept that certain levels of risk are tolerable or even desirable, to delegate discretion for managing this risk, and to set goals and limits for such discretion and the means to monitor them. The converse can also be true with policy leaving the organization open to unrecognized and unwarranted speculation by various business functions.

Another way that policy fails is in its understanding and acceptance by company staff. For price risk management this is a considerable problem as many major departments, beyond the risk desk, have active roles to play. Policies need a roll-out for front line crew members – the lack of which can leave staff unaware of their involvement and the reasons why their contribution is important. Policies must react to change – a want of updates that reflect new aspects of the business can make a price risk management impractical, and cause it to be quickly stranded by the wayside. Over specificity can be a further problem, as facets will pertain to some departments and not others. Details can be left to guidance notes crafted by each business unit with the risk desk along with procedure documents. None of this is obvious to the average tool-and-die guy (or accountant, salesperson or treasurer) – policy implementation needs expert guidance.

The impact of poor policy or its lack of use often takes time to surface. Proper price risk management involves many units of a business so misdirection from poor policy has the same effect as the gradual misalignment of the wheels of a race car; over time the car doesn’t feel right on the track and eventually the stress produced causes something to break, possibly at the worst time. For businesses, the effects will take the form of volatile financial results that can leave accountants scratching their heads for causes. Left unresolved the resulting problems could run a company off the track.

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