Meeting the pace of change

Energy trading is advancing so quickly it's sometimes difficult for software to keep pace. Energy Risk's software survey reveals almost half of respondents changed systems in 2006. David Watkins reports

Demand for increasingly sophisticated energy trading and risk management (ETRM) software grew significantly in 2006, spurred by the need to manage volatile energy prices and the spread of more sophisticated structured trading.

"We've seen significant development acceleration in the last 12 months," says James Kemp, managing director of Stentra, a specialist financial markets technology consultancy. "I could reel off at least five major software implementations for major banks that are happening right now, and that's pretty extreme compared with 12 months previously."

Judging by the results of the 2007 Energy Risk software survey, conducted in January and February, many respondents are happy with their current systems. Yet the results also reveal that such satisfaction has come at a price, with 44% of respondents having changed their software in 2006 because of unhappiness with previous systems.

While this demonstrates that companies are ready to invest in ETRM, it raises questions as to the software's success in keeping pace with the market and anticipating change. Crucially, it asks whether or not the substantial replacement is because of the sheer pace of market evolution, poor implementation choices or a combination of both.

"Basically what happens is that 18 months after purchasing software, energy companies find themselves using something that is dramatically out of date," says Gary Vasey, vice-president of UtiliPoint International, a research and information provider for energy companies, utilities, investors, regulators, and industry service providers. "It probably doesn't meet market requirements because of some new development in the marketplace, regulatory or otherwise. But to upgrade to the current version is as expensive, costly and complex as simply going back out into the marketplace and starting all over again."

The survey also showed that in the battle of achieving complete front-to-back integration, still no one company stands out. Respondents were asked which software companies they use for front, middle and back-office activities, and a different firm topped each category. TradeCapture, OpenLink and Murex were the respective winners (as shown in table 1).

With volumes surging and multiple commodities being traded, sophisticated risk tools and more professionally built systems are needed to manage everything from the transactions and their risks to settlement and accounting issues, especially as the larger players step up their presence in the space.

"The older systems are just not working for users anymore, they're too costly to support," says Jill Feblowitz, practice director of business technology at Energy Insights, a research-based advisory and consulting firm. "There's a big interest on the part of the companies to get more real time, intra-day into their systems, and if you were to think of a current weakness shared by a lot of the industry, it's a lack of flexibility in older legacy systems, the inability to convey more real-time information than it does already."

Indeed, comments from those surveyed noted that the industry has made successful strides into new markets, multi-commodity trading, secure internet transactions and Sarbanes Oxley compliance over the past 12 months. Nevertheless, a perceived lack of real-time feeds and poor service support were glaring bugbears, along with weak interfaces and a lack of simplicity.

Yet there is clearly a willingness to invest in new products in an effort to keep up with the pace of market development. The Energy Risk survey found that almost half of all respondents implemented new software in 2006, while 62% had higher software budgets for 2007 than 2006. This is particularly true of investment banks, as they ramp up their energy trading teams to exploit market opportunities.

"A group that was once fairly starved of investment and technology is suddenly now having money thrown at it and being told to go and get themselves up and running," says Kemp. "Obviously what happens in that situation is that nobody can build anything fast enough from scratch, and you have to reach for an ETRM package to get started."

Indeed, when asked if their software was built in-house, off-the-shelf, or a mixture, the majority of respondents (38%) reported that their software was mostly off-the-shelf, with some in-house add-ons, followed by 19% using a 50/50 mix.

The degree to which such products offer real time functionality and straight through processing (STP) – which enables electronic trading and payment transactions without the need for re-keying or manual intervention – is becoming increasingly crucial in mitigating risk.

Yet while STP's same day or even faster abilities minimise settlement risk, not all systems offer it to the same degree. When asked how current systems need to be improved, those surveyed called for more choices in software that can adapt to different ways of doing business, offer compatibility over different systems and do so in a user friendly manner.

According to the survey, the most widely used front-office vendor is TradeCapture, which secured 23% of the vote. The company specialises in STP systems, from deal entry, order routing, trade confirmation, scheduling and invoicing, to systems that calculate the real-time position, P&L, and value-at-risk of every trade across oil, refined products, natural gas, gas-to-liquids, and foreign exchange – as well as physical and financial positions.

Vincent Annunziata, chief executive of TradeCapture, notes that as volume has increased, so has the complexity of trading patterns for software to deal with. "Traders are now also doing basket trades where they trade a group of commodities in one shot. Companies are hiring bigger teams and expanding into new commodities. You're starting to see the crossover into other commodities such as ethanol and agricultural. With so much intra-day volatility you have to know what your exposure is at any given time, from both a positional risk and credit risk point of view."

The recent spate of consolidation in the exchange space – from IntercontinentalExchange's acquisition of the New York Board of Trade and the likes of the Chicago Mercantile Exchange's proposed merger with the Chicago Board of Trade – is also reinforcing the need for easily adaptable systems.

Annunziata notes that with new products being listed, reference data and interfaces need to be as generic as possible. "If another exchange opened up tomorrow you want to be able to take the new information and feed it in without disrupting the rest of the system," he says. "We've been working for the past few years on creating one nice, tight core module that basically takes in all these new feeds and allocates them real-time to the proper portfolios." He says the modules' success lies in its anticipation that "the volume of electronic trading has increased tremendously and is poised to continue growing at a rapid pace".

Other issues are providing equally considerable challenges, particularly in terms of compliance. In the US, the Sarbanes Oxley Act demands that systems produce auditable, repeatable, provable, testable data for all outside auditors and shareholders to see.

In Europe, factors such as emissions trading have also come into play, while the lowering of the entry barrier to trade at various exchanges around the world has prompted growth in exchange clearing, electronic trading and the various ways in which traders can conduct business such as voice broking and interactive messaging.

Companies in the process of selecting ETRM software must therefore realise that "the risks have gone up, not just in terms of exposure to market price, but risks like actual software implementation," according to UtiliPoint International's Vasey.

With more and more companies embracing the technology, there is now a burgeoning industry for implementation consultancy, with buyers relying on third-party expertise to explain the different solutions and their vendors in the marketplace.

Unfortunately the quality of such advice is varied, and with companies spending in excess of $1 million every three years to implement new systems, returns on investment can be hard to come by. "If you talk to companies in North America you're going to find that there are many failures of ETRM implementation projects where the system is either poorly implemented or sometimes is not implemented at all," says Vasey.

"Some major energy companies have some flavour of every system that was ever created and brought to market," he says. "Part of that issue is around selecting the correct solution in the first place."

Indeed, the risks of software implementation are as considerable as the risks the software is itself intended to manage, and those companies that decide not to reinvest regularly can find themselves out of touch with a rapidly changing industry. The Energy Risk survey found that 17% of users had not implemented software for somewhere between five and ten years.

This can be problematic within a software space of over 80 software providers, where 12 months might see three or four mergers and acquisitions that can effectively 'strand' older systems, rendering them obsolete.

"Some companies have either been acquired or gone bust and so there are many stranded systems around, particularly in the US," says Vasey. "A very high number of North American utilities are essentially operating on a custom solution based on a 10-year old system. Yet technology has moved on, markets have moved on, these systems are not going to do the job. You may as well be using spreadsheets."

Lack of after-sales support

A common sentiment found throughout the survey was general dissatisfaction with some vendors' IT support once the system was installed. Some experts believe that companies are stretching themselves too thinly in pursuit of profit.

"You can compare it to buying a car," says Addam Alderete of MRE Consulting, a professional services firm that offers life-cycle system implementations for energy-related industries, from software selection and architecture to testing and implementation support.

"You might like a Porsche, I might want a Mercedes, and we know what functionality we want and try and get the best deal, cheapest price and best warranty. But both of us forget to look at what services are provided in the warranty of the car. That's where a lot of people get bitten."

Alderete notes that many companies are unable to provide support services in a timely fashion for their customer base. "Many companies are too busy offering people they haven't even met new deals. Wall Street just wants to see the 80% license revenue and 20% service revenue, not the other way round."

Analysts also regard the support issues to be because of company structuring. "The problem gets to be internal to the process," says Feblowitz. "Different divisions within the companies have different visions of what they want for positions and it's the inability to agree on what the single thing should be."

Such a scenario could be advantageous for smaller software developers who are looking to increase their presence in the space. Indeed, it is telling that Encompass Technologies, one of the companies rated most highly for software support in the survey, currently employs a total of 12 staff and has six clients.

A front-to-back system in the same space as OpenLink and Allegro, EnCompass's system is designed to handle both physical and financial transactions and is known for its integrated risk analytics, deal capture and physical scheduling capabilities.

"We focus on product development and customer support rather than marketing efforts," says EnCompass president Andy Bout. "It's important to maintain close relationships and offer as much support as possible. Can you do that with 40 clients? It gets very difficult."

As far as 2006 was concerned, the companies deemed the ETRM software market leaders by survey respondents were OpenLink and Murex, each with 20% of the vote. What company the accolade goes to after the next 12 months will be decided by further innovation as the industry looks to address some of the key challenges regarding support, installation and providing more real-time market feeds.

"We have a lot of work to do," says OpenLink chief executive Coleman Fung, who attributes his company's success to a development budget that has remained at 40% throughout the company's history. "It's a good cycle to be in. You sign up top tier banks and energy firms and they in turn keep feeding us with the most rigorous and demanding trading and risk management requirements. The job is never done."