Operational Risk

Operational risk encompasses everything that can go wrong in executing a trade — from vessel delays to documentation errors to system failures. While less visible than price risk, operational failures can be just as costly.

Types of Operational Risk

Risk Categories

Category	Examples	Potential Impact
Execution	Wrong price, quantity, counterparty	Financial loss
Documentation	L/C discrepancies, B/L errors	Payment delays
Logistics	Vessel delays, quality issues	Demurrage, claims
Systems	IT failure, data errors	Disruption
People	Errors, fraud, key person	Loss, reputation
External	Weather, accidents, disasters	Disruption

Operational Risk Examples

OPERATIONAL RISK SCENARIOS
──────────────────────────

DOCUMENTATION ERROR:
Invoice shows "25,000 MT" but B/L shows "25,000,000 KG"
L/C rejected for discrepancy
Result: 7-day payment delay, $50K extra interest

LOGISTICS FAILURE:
Vessel breakdown mid-voyage
15-day delay
Result: $600K demurrage, customer relationship damaged

SYSTEM FAILURE:
ETRM system down for 4 hours
Trades not captured in real-time
Result: Unmonitored position, potential limit breach

EXECUTION ERROR:
Trader buys 100,000 MT instead of 10,000 MT
Fat finger error
Result: $2M loss liquidating excess position

FRAUD:
Fake warehouse receipts
Inventory doesn't exist
Result: $50M loss (Qingdao metals fraud 2014)

Control Framework

Control Categories

Control Type	Description	Examples
Preventive	Stop errors before they occur	Dual approval, validation
Detective	Identify errors when they occur	Reconciliation, monitoring
Corrective	Fix errors after detection	Adjustment procedures

Key Controls by Process

TRADE EXECUTION CONTROLS
────────────────────────

1. DEAL CAPTURE
   - Four-eyes principle (dual entry)
   - Counterparty validation
   - Price reasonableness check
   - Limit pre-check

2. CONFIRMATION
   - Independent confirmation
   - Matched to deal ticket
   - Signed by authorized person

3. SETTLEMENT
   - Three-way match (contract, delivery, invoice)
   - Bank details verification
   - Payment approval levels

Documentation Controls

DOCUMENTATION CONTROL CHECKLIST
───────────────────────────────

PRE-SHIPMENT:
□ L/C terms match contract
□ Document list complete
□ Inspection company booked
□ Shipping instructions issued

AT LOADING:
□ B/L matches L/C requirements
□ Quality certificate obtained
□ Quantity certificate obtained
□ All documents in correct name

PRESENTATION:
□ All documents present
□ Cross-checked for consistency
□ Presented within validity
□ Copies retained

DISCREPANCY CHECK:
□ Spelling matches exactly
□ Quantities reconcile
□ Dates comply with L/C
□ Descriptions match

Incident Management

Incident Classification

Severity	Definition	Response Time
Critical	>$1M loss or major disruption	Immediate
Major	$100K-$1M or significant disruption	4 hours
Moderate	$10K-$100K or minor disruption	24 hours
Minor	<$10K, no disruption	1 week

Incident Response Process

INCIDENT RESPONSE WORKFLOW
──────────────────────────

1. IDENTIFICATION
   - Incident detected
   - Initial assessment
   - Severity classification

2. ESCALATION
   - Notify appropriate level
   - Assemble response team
   - Contain impact

3. INVESTIGATION
   - Root cause analysis
   - Document facts
   - Identify gaps

4. REMEDIATION
   - Implement fix
   - Prevent recurrence
   - Update controls

5. REPORTING
   - Incident report completed
   - Lessons learned shared
   - KPI updated

Root Cause Analysis

ROOT CAUSE ANALYSIS: 5 WHYS
───────────────────────────

INCIDENT: L/C rejected, $200K interest cost

WHY 1: Documents had discrepancy
WHY 2: Invoice quantity didn't match B/L
WHY 3: Different rounding conventions used
WHY 4: No reconciliation before presentation
WHY 5: Checklist step skipped due to time pressure

ROOT CAUSE: Process not followed under pressure

CORRECTIVE ACTION:
- Mandatory checklist sign-off
- Electronic reconciliation tool
- Extended document prep time

Business Continuity

BCP Framework

BUSINESS CONTINUITY PLAN
────────────────────────

SCENARIO: Primary office unavailable

IMMEDIATE (0-4 hours):
- Activate backup site
- Critical staff relocate
- Essential systems restored

SHORT-TERM (4-24 hours):
- Full trading capability
- All staff informed
- Customer communication

MEDIUM-TERM (24-72 hours):
- Normal operations resumed
- Alternative site fully operational
- Investigation initiated

LONG-TERM:
- Return to primary (when safe)
- Post-incident review
- Plan updates

Critical Systems

System	Recovery Target	Backup
ETRM	4 hours	Hot standby
Risk systems	4 hours	Hot standby
Email	2 hours	Cloud-based
Treasury	4 hours	Backup site
Phone/comms	2 hours	Mobile backup

Logistics Risks

VESSEL RISK SCENARIOS
─────────────────────

SCENARIO 1: Vessel detention at port
Cause: Customs inspection
Impact: 5 days delay, $150K demurrage
Mitigation: Proper documentation, compliance

SCENARIO 2: Off-spec cargo
Cause: Tank contamination on vessel
Impact: Quality claim, buyer rejection
Mitigation: Tank inspection, surveyor at load

SCENARIO 3: Weather delay
Cause: Typhoon in discharge area
Impact: 10 days waiting
Mitigation: Weather clauses, insurance

SCENARIO 4: Canal closure
Cause: Suez blocked (Ever Given 2021)
Impact: Major rerouting costs
Mitigation: Alternative routes, insurance

Quality Risk Management

QUALITY CONTROL PROCESS
───────────────────────

PRE-LOADING:
1. Supplier quality certificate reviewed
2. Independent pre-shipment inspection
3. Samples retained

LOADING:
4. Tank inspection (vessel)
5. Continuous monitoring during loading
6. Composite sample taken

IN-TRANSIT:
7. Sample retained on vessel
8. Temperature/condition monitoring

DISCHARGE:
9. Discharge inspection
10. Comparison to B/L specs
11. Claims filed if needed

Fraud Prevention

Fraud Types

Type	Description	Red Flags
Document fraud	Fake B/Ls, warehouse receipts	Unfamiliar issuer
Carousel fraud	Same goods invoiced multiple times	Circular trades
Collusion	Employee with counterparty	Unusual pricing
Ghost shipments	Non-existent cargo	Unverified vessels

Fraud Controls

FRAUD PREVENTION CONTROLS
─────────────────────────

COUNTERPARTY:
□ KYC verification complete
□ Site visit (if new)
□ References checked
□ Ownership verified

DOCUMENTATION:
□ B/L authenticity confirmed
□ Vessel position verified (AIS)
□ Inspector is known/approved
□ Warehouse physically visited

TRANSACTIONS:
□ Market price reasonableness
□ No circular arrangements
□ Payment to verified account
□ Dual approval on payments

MONITORING:
□ Unusual transaction alerts
□ Related party tracking
□ Employee trading checks
□ Whistleblower hotline

Operational KPIs

Performance Metrics

KPI	Definition	Target
Trade error rate	Errors / total trades	<0.5%
Doc discrepancy rate	Discrepancies / L/C presentations	<10%
Demurrage incidents	Claims per shipment	<5%
Settlement on-time	Payments on time	>98%
System availability	Uptime percentage	>99.5%
Incident count	Monthly incidents	Declining

Monthly Report

OPERATIONAL RISK MONTHLY REPORT
───────────────────────────────

                    Current    Target    Trend
Trade errors        0.3%       <0.5%     ↓
Doc discrepancies   8%         <10%      ↔
Demurrage rate      4%         <5%       ↔
On-time settlement  99%        >98%      ↑
System uptime       99.8%      >99.5%    ↔

INCIDENTS:
Critical: 0
Major: 1 (vessel delay, $300K)
Moderate: 3
Minor: 8

TOTAL LOSS: $350,000

ROOT CAUSES:
Documentation: 40%
Logistics: 35%
Systems: 15%
People: 10%

ACTIONS:
- Documentation training scheduled
- New reconciliation tool deployed
- Carrier review completed

Key Takeaways

Operational risk is as important as market risk — Failures can be equally costly
Controls must be embedded in processes — Not just audited after the fact
Incidents must be investigated — Root cause analysis prevents recurrence
Business continuity requires planning — Can’t improvise during crisis
Fraud requires vigilance — Multiple controls, healthy skepticism
KPIs drive improvement — Measure to manage

References

Basel Committee Operational Risk
ISO 22301 Business Continuity
COSO Internal Control Framework
ICC Trade Finance Fraud Guidelines