On May 7th, the CFTC Division of Market Oversight issued an advisory regarding compliance with speculative positions limits emphasizing compliance during intra-day. This advisory clarifies that CFTC intends to use its regulatory authority to enforce ‘real time’ risk monitoring for compliance. This ruling will have implications for commodity trading firms, FCMs, algorithmic trading funds, hedge funds, and their risk managers. They must have real time risk management systems to ensure that they comply with the law. It will not be merely sufficient to just apply position limits at the pre execution phase. In the world of using algorithms for high frequency trading, this becomes even more important and necessary as witnessed in events of last Thursday (May 6, 2010) when high frequency trading caused precipitous downfall in equity markets.

In my opinion, monitoring risk in real time is an indispensible tool to ensure market stability. My recently written white paper on 4^th Quadrant commodity trading, I show that concepts applied to commodity trading emphasize the need for organizations to manage risk in real time.   This recent CFTC advisory is an attempt to create external discipline to ensure that trading entities not have such concentration risk. Such concentration risk not only puts an entity out of business but also disrupts the market as a whole. Many FCMs enforce ‘pre execution’ position limits to limit order beyond a certain size. That is fine but it does not view overall position in conjunction with the trades already on an entity’s book. This requires a real time trading and risk system that monitors each trader’s total position along with the entity’s total position in real time. And it ensures that positions not only comply with the law but also comply with the internal risk policy and risk management’s best practices. Companies should have a risk system that can ensure real time position keeping and alerts. Companies need to develop a way to ensure connectivity with exchanges and FCMs to get positions in real time, or they buy risk systems from vendors.  

I think that this ruling should start conversations in the IT, Risk Departments, and with the Principles of commodity trading funds (Algo funds, CTA, or hedge funds) about installing such systems. It can be a very low cost insurance policy to avoid liquidity squeeze. For further information and to share ideas, feel free to contact me at directly at SunGard Energy and Commodities:

Moazzam Khoja, CFA
SVP Strategy
SunGard Energy and Commodities
Moazzam.khoja@sungard.com
713-210-8136

Kiodex Real Time provides a complete solution for monitoring intra-day compliance, please contact us for a free consultation :
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About Moazzam Khoja, CFA
Moazzam is senior vice president of strategy for SunGard Kiodex. He has worked for the past thirteen years in the commodity risk management area including issues related to commodity derivatives valuations, structuring of complex energy and credit derivatives, and hedging process and analysis. He has authored several articles in leading industry publications to address these issues. He obtained his MBA from the Columbia Business School in 1996 and his chartered financial analyst designation in 2003. 

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