Similarity and differences within BANK and COMMODITY RISK MANAGEMENT DONATO ABBATE

Similarity and differences within BANK and COMMODITY RISK MANAGEMENT DONATO ABBATE

COMMODITY RISK MANAGEMENT An Introduction to Commodities Pricing Commodity Contracts Calculating VaR for Commodities Governance and Controls in Commodity Firms

Introduction What is a Commodity? A Commodity is. An article of commerce A transportable article of trade or commerce that can be bartered or sold. As defined in the Commodity Exchange Act, includes the agricultural commodities enumerated in Section 1a(4) of the Commodity Exchange Act and all other goods and articles, except onions as provided in Public Law 85-839 (7 USC 13-1), Epistemology?! the word commodity came into use in English in the 15th century, derived from the French word "commodité", similar in meaning to "convenience" in terms of quality of services. The Latin root meaning is commoditas, referring variously to the appropriate measure of something; a fitting state, time or condition; a good quality; efficaciousness or propriety; and advantage, or benefit -3-

Commodity Markets The Rise of Commodity Trading The earliest commodity trading took place thousands of years ago, however commodity instruments and markets as we know them now developed in the US in the 1800 s. In the early 1800s, the local farmlands and cattle industries made Chicago a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. A market emerged enabling trade in "to arrive" or "cash forward" contracts to protect grain merchants from price volatility. Trading was originally in forward contracts The first futures contract was written on corn, on March 13, 1851. Chicago Exchange trades more than 70% of its Futures contracts on its "Globex" trading platform. It accounts for over 45.5 Billion dollars of nominal trade (over 1 million contracts) every single day in "electronic trading" Now commodity futures, options and other derivatives are traded ~400 BC ~1800 1848 1851 1865 1874 2006 The origins of futures trading can be traced to Ancient Greek and Phoenician civilizations Source: Wikipedia Forward contracts became standard, however, most forward contracts weren't honored by both the buyer and the seller! In 1848, the Chicago Board of Trade (CBOT), became the world's first modern futures exchange. -4- In 1865, standardized futures contracts were introduced. The Chicago Produce Exchange was established in 1874 and renamed the Chicago Mercantile Exchange (CME)

Commodity Markets Major Commodity Markets Major Futures Exchange Table 1.6 Major Futures Exchanges in the World for 2003 EXCHANGE 2003 Volume (Futures Only) Top 20 % Volume Eurex (Germany) Chicago Mercantile Exchange (USA) 668,650,028 530,989,007 24.55 19.49 Chicago Board of Trade (USA) Euronext-Liffe (Netherlands) Mexican Derivatives Exchange (Mexico) 373,,669,290 273,121,004 173,820,944 13.72 10.03 6.38 Bolsa de Mercadorias e Futuros (Brazil) New York Mercantile Exchange (USA) 113,895,061 111,789,658 4.18 4.10 Tokyo Commodity Exchange (Japan) 87,252,219 3.20 London Metals Exchange (UK). 68,570,154 2.52 Korea Stock Exchange (South Korea) 62,204,783 2.28 Sydney Futures Exchange (Australia) 41,831,862 1.54 National Stock Exchange of India (India) 36,141,561 1.33 SIMEX (Singapore) 35,356,776 1.30 International Petroleum Exchange (UK) OM Stockholm (Sweden) Tokyo Grain Exchange (Japan) New York Board of Trade (USA) Bourse de Montreal (Canada) MEFF Renta Variable (Spain) Tokyo Stock Exchange (Japan) 33,258,385 22,667,198 21,084,727 18,822,048 17,682,999 17,109,363 15,965,175 1.22.83.77.69.65.63.59 Commodity markets are markets where raw or primary products are exchanged. The Organized Exchange Not-for-Profit Organization Structure Members hold exchange memberships or seats that allow them to: Trade on the exchange Have a voice in the exchange s operation For-Profit Organization Structure Members receive shares or stocks. Demutualize Total Top 20 2003 Futures Volume 2,723,882,242 100% Source: Futures Industry Association. -5-

Commodity Markets Clearinghouses Buyer Obligations without a clearinghouse Seller Buyer Obligations with a clearinghouse Clearinghouse Seller Clearinghouses Guarantee that the traders will honor their obligations (solves issues of trust). Each trader has obligations only to the clearinghouse, not to other traders. Each exchange uses a futures clearinghouse. Clearinghouses may be part of a futures exchange (division), or a separate entity. Due to 2000 CFMA, clearing arrangements vary across industries. Clearinghouses are perfectly hedged by maintaining no futures market position of their own. Clearinghouse Table 1.7 Major Futures Clearing Organizations Major Futures Clearing Organizations The Clearing Corporation (CCorp) Chicago Mercantile Exchange Clearinghouse Kansas City Board of Trade Clearing Corporation Energy Clear Corporation MGE Clearinghouse NYMEX Clearinghouse New York Clearing Corporation The Options Clearing Corporation The London Clearinghouse Affiliated Exchanges US Futures Exchange and the Merchants Exchange of St. Louis Chicago Mercantile exchange With clearing link to CBOT Kansas City Board of Trade Exempt Commercial Markets Minneapolis Grain Exchange New York Mercantile Exchange New York Board of Trade OneChicago, NQLX, & option exchanges Exempt Commercial Markets and OTC markets Sources: The CFTC web site, www.cftc.gov. -6-

Terminology Example Commodities Traditional, Exchange Traded Commodities Alternatively Traded Commodities Agricultural (Grains, and Food and Fiber) Corn CBOT Oats CBOT Rough Rice CBOT Soybeans CBOT Soybean Meal CBOT Soybean Oil CBOT Wheat CBOT Cocoa NYBOT Coffee NYBOT Cotton NYBOT Sugar NYBOT Industrial metals Copper LME Lead LME Zinc LME Tin LME Aluminum LME Aluminum alloy LME Nickel LME Recycled steel Rotterdam Precious metals Gold CBOT Platinum NYMEX Palladium NYMEX Silver CBOT Livestock & Meat Lean Hogs CME Pork Bellies CME Live Cattle CME Feeder Cattle CME Energy Light, Sweet Crude NYMEX Brent Crude ICE Ethanol CBOT Natural Gas NYMEX Heating Oil NYMEX Gulf Coast Gasoline NYMEX RBOB Gasoline NYMEX Propane NYMEX Uranium NYMEX -7- Other Rubber Palm Oil Wool Poly Propolyne Agricultural Products Fresh Flowers Cut Flowers Melons Lemons Tung Oil Gum Arabic Pine Oil Xanthan Milk Tomatoes Grapes Eggs Potatoes Figs Rare metals Germanium Cadmium Cobalt Chromium Magnesium Manganese Molybdenum Silicon Rhodium Selenium Titanium Vanadium Wolframite Niobium Lithium Indium Gallium Tantalum Tellurium Beryllium Minerals and Materials Asphalt Aggregate Arsenic Borax Boron Gypsum Asbestos Chlorine Fluoride Cement Sulfuric Acid Carbon Dioxide Flourspar Bromine Titanium Dioxide

Terminology Basic market terms Cash / Spot Price Some Starting Price Terminology Present delivery price of a given commodity being traded on the spot market. Settlement Price Average price at which a contract trades, calculated at both the open and close of each trading day. Used to determine margin requirements. Forward Price Agreed upon price of an asset in a forward contract. Date terminology Pricing Date Trade Date Prompt Date 0 T Date on which the contract is priced Date on which the transaction occurs Date on which the buyer of an option will buy or sell the underlying commodity if the option is exercised -8-

Terminology Market Situation Contango describe an upward sloping forward curve (as in the normal yield curve). One says that such a forward curve is "in contango" (or sometimes "contangoed"). Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery. Backwardation means a downward sloping forward curve (as in an inverted yield curve): one says that the forward curve is "in backwardation" (or sometimes: "backwardated"). Formally, is described as, the situation where, and the amount by which, the price of a commodity for future delivery is lower than the spot price, or a far future delivery price lower than a nearer future delivery. Contango vs. Backwardation -9- Forward Price 2,000.00 1,500.00 Jan 05 Jan 06 Forward Curve Aluminum Jan 07 Jan 08 Month Jan 09 Jan 10 Forward price Notable examples of backwardation include: Crude oil. Copper circa 1990, apparently arising from market manipulation by Yasuo Hamanaka of Sumitomo Corporation. NYMEX traded natural gas (May 2007). FX: The Australian dollar, priced in Japanese yen terms (AUD/JPY), 2006: Australian dollar bonds pay much more interest at every point in the yield curve than Japanese yen bonds

Terminology Futures Vocabulary Margin and Settlement Cash or m/sec deposited by investor with his/her broker Initial Margin: funds required in a commodity account when a position either long (bought) or sold (short) is established. Initial Margin Call: margin call issued when a new position is taken. Maintenance Margin When margin reaches a minimum maintenance level, the trader is required to bring the margin back to its initial level. The maintenance margin is generally about 75% of the initial margin. Daily Settlement Process by which traders are required to realize any losses in cash immediately (marked-tothe-market). The losses are usually deducted from the margin deposit. -10-

Terminology Futures Vocabulary Lot unit of trading defined quantity (contract size), i.e. Brent 1,000 barrels, gasoil 100 mt on the ICE defined quality, delivery period, etc. Delivery month refers to the period when physical delivery can commence or cash settlement can occur set at monthly intervals (each month has a letter code) Last trading day day when trading officially ceases majority of open positions are closed out prior to expiry physical delivery follows last trading day. Minimum price movement ( tick ) minimum amount by which a quotation can move in any one price movement. Example: Brent Gasoil min. mvt. 1 cent 25 cents value $10 $25 Bid commitment to buy at a specified price Ask commitment to sell at a specified price -11-

COMMODITY RISK MANAGEMENT An Introduction to Commodities Pricing Commodity Contracts Calculating VaR for Commodities Governance and Controls in Commodity Firms

Pricing Commodity Contracts Commodity Instrument Pricing - The Basics Commodity instruments are different from other financial assets because (originally) a physical product was delivered as part of exercising the instrument. More recently commodity instruments have been developed which are purely financial non-delivery or cash only instruments, which have commodities as underlying assets. Commodity instruments have become widely popular for both speculative and hedging purposes. Some More Terminology The future date is called the delivery date or final settlement date. The futures price is the price which is agreed to buy or sell an asset at in the future, without putting up any money now. The price of the underlying asset on the delivery date is called the settlement price. The spot price of a commodity is the price at which the good can be sold for immediate delivery Characteristics of Commodity Instrument Contracts (Most )short and long positions of commodities contracts (with delivery) match 1:1. Some commodities have seasonal swings in price increases in price does not indicate profit opportunities, the price can rise and any rate lower than (storage cost + interest rate) Forward Price Formula The forward price is given by: where F is the forward price to be paid at time T e x is the exponential function ( for calculating compounding interests) r is the risk-free interest rate q is the cost-of-carry S(t) is the spot price of the asset D i is a dividend which is guaranteed to be paid at time t i where 0 < t i < T. A simplified form gives the Forward price at time t. (no dividends or cost-ofcarry) -13-

Pricing Commodity Contracts Future and Forward contracts Future / Forward contracts What it Is: Futures An agreement to buy or sell an asset at a preagreed future point in time, for a pre-agreed price. Everyday, the contract is Marked to Market Characteristics: Standardized contract traded on an exchange Customised contract Initial and variation deposits (margins) required Fixed price In most cases, physical delivery may occur. Standard delivery location and period Liquid No counterparty risk Commissions paid Forwards What it Is: Also an agreement to buy or sell an asset at a pre-agreed future point in time, for a pre-agreed price, however no money or goods change hands until the maturity of the contract. Characteristics: OTC contract (phone) Standard contract No margin deposit requirement. Pricing formula Flexible delivery location and period Illiquid Counterparty risk No commission -14-

Pricing Commodity Contracts Basic Commodity Instruments - Forward Contracts v ( A Forward contract represents the agreement (an obligation) between two parties to buy or sell an asset at a pre-agreed x,t ) = e( future point in time, for a pre-agreed price. No money or assets change hands until the contract reaches the final settlement date. Forward contracts are not necessarily traded on an exchange, they may just involve an agreement between two parties. Forward Price at t=0 Contract > 0 F(t) > F(o) A long forward contract position is positive when the commodity forward price is greater than the forward price at time t=0. Forward Price = Spot Price at t=t Forward Price +$ Contract Pay Off: = S(T) F(o) > 0 > 0 < 0 0 Time Contract < 0 F(t) < Fo A long forward contract is negative when the commodity forward price is less than the forward price at time t=0 T -15-

Pricing Commodity Contracts Basic Commodity Instruments - Futures Contracts A Futures contract represents the agreement (an obligation) between two parties to buy or sell an asset at a pre-agreed future point in time, for a pre-agreed price. Everyday, following the close of trading the contract is zeroed-out meaning that the difference in the forward price during the day is paid out to/by the investors. The futures contract is then worth 0 at start of business the next morning. This is called Marking to Market and requires that liquid collateral from both parties be held by an independent intermediary. Futures are generally traded on a futures exchange. Forward Price at t=0 F(t-1) Marking to Market Each Day Payoff = F(t) F(t-1) Pay Off at T: F(T)= S(T) F(T-1) Forward Price +$ +$ -$ ~0 -$ +$ -$ +$ 0 1 2 3 Time 5 6 7 8 (Days) -16-

Pricing Commodity Contracts Early Commodity Instruments - Black Model for Commodity European Options The holder of a commodity option has the right but not the obligation to purchase (sell) a fixed quantity of a specific commodity at a fixed time in the future at a specified price. European Commodity Options are exercised only at maturity and not before hand Valuing Commodity Options using Black 1976 Model The volatility of the commodity price is estimated as constant σ² The contract is valued as a function of the futures price and time A riskless position can be created by taking a long position in the option and a short position in the related futures contract with the same maturity date. Solving for the option value gives the European Commodity Option: ( ) Note compared to the typical European option solution, a factor of Fe rt is now just F because the investment in a futures contract is 0, therefore causing the interest rate factor to drop out of the formula. -17-

Pricing Commodity Contracts Pricing American Commodity Options American commodity options can be priced using the model developed by G. Barone-Adesi and R. E. Whaley in the paper Efficient Analytic Approximation of American Option Values (1987). Goal of the paper There does not exist any analytic solution to the pricing of American options. Usually, finite difference methods are used to derive prices, but they are computationally expensive. The authors of the paper aims at providing an approximation to the price of American options on commodities which is accurate and does not require much computational power. Generalities on American options Main feature: can be exercised before maturity. Objective of the holder: determine the optimal exercise time. This optimal time depends on the movements of the stock S. If S is high enough to make the payoff of the option be larger than its value, then it is worth exercising. Otherwise, holding the option is more valuable than exercising it, therefore it is better waiting. The optimal exercise time is given when S touches the exercise boundary. -18-

Pricing Commodity Contracts Pricing American Commodity Options Quadratic approximation of American Call and Put values Assumption: The cost of carry b is a constant proportional value. Call: Let us call C(S,T) the American commodity option value and c(s,t) the European one. Both satisfy the following PDE: American options are at least as expensive as European options, and sometimes more when it is likely that there will be early exercised. The early exercise premium is defined as It also satisfies the PDE. After some transformations and approximations, C( S, T ) is expressed as for S below the exercise boundary. Above the exercise boundary, we have The exercise boundary is found iteratively so that the price of the American option is continuous. Put: 1 2 2 σ S V 2 Same approach: the exercise boundary is first iteratively determined as solution of an equation expressing the continuity of the Put price. Then, when S is above the exercise boundary, SS + bsvs rv + Vt ε ( S, T ) = C( S, T ) c( S, T ). C C( S, T ) = S K. = 0 P ( S, T) + 2 T c ( S, T) + A1 ( S, S*, b, r, T) = p( S, T) A ( S, S*, b, r, ) and when S is below the boundary, P( S, T ) = K S. Conclusion Accurate method, quite quick to implement and use. Only the computation of the exercise boundary is not straightforward. Very general. For b=r we obtain the price of an American stock option. For b=0 and S F we get the price of an American commodity futures option. -19-

Pricing Commodity Contracts More accurate models for commodity options As for pricing equity options, the basic models present several big limitations, which can be overcome by more sophisticated models. Lognormal Brownian Motions are not accurate to model fat tail distributions. For stock prices this is a major criticism of Black and Scholes model. Commodity prices have the following features: erratic behaviour (in particular electricity) due to their non-storable nature and dependence on physical transmission networks. jumps, spikes and stochastic volatility mean-reversion Another challenge is the limited market data available. Literature: Bernard J.T., Khlaf L., Kichian M. and McMahon S, Forecasting Commodity Prices: GARCH, Jumps and Mean- Reversion, Working Paper 2006-14, Bank of Canada. Higgs H. and Worthington A.C., Stochastic price modelling of high volatility, mean-reverting, spike-prone commodities: The Australian wholesale electricity market, Faculty of Commerce, Papers, University of Wollongong, 2006. Trolle A.B. and Schwartz E.S., Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives, NBER Working Paper Series, 2006. A last feature of some commodity futures and options is seasonality. See Richer M. and Sørensen C., Stochastic Volatility and Seasonality in Commodity Futures and Options: The Case of Soybeans. -20-

COMMODITY RISK MANAGEMENT An Introduction to Commodities Pricing Commodity Contracts Calculating VaR for Commodities Governance and Controls in Commodity Firms

Calculating VaR for Commodities Introduction to Measuring VaR for Commodities Although traditional VaR modeling methodologies can be used to model VaR for commodity risk, modeling commodity risk involves taking even more aspects into consideration due to some of the particular aspects of commodity information. VaR The Value at Risk (VaR) indicates the loss within a given time horizon with a given confidence level in normal market conditions. The main features of the VaR include: VaR is an absolute risk measure (risk is quantified in absolute monetary terms, not as a deviation to some benchmarks) VaR is a static measure (it assumes a static portfolio during the time horizon of the analysis) VaR is an asymmetric measure (it only considers events with a an adverse impact on the P&L) The main use of the VaR include: Quantification, control and forecast of the market risks of products, portfolios or organizational units Quantification of the risk adjusted performance of products, portfolios or organizational units The main components of the VaR include: Time horizon, (i.e. the time period of the analysis) Confidence level (i.e. the probability of not surpassing the VaR value in the given time horizon) Risk factors (i.e. the market factors with an impact on the portfolio) Methodology (i.e. the algorithm for the var calculation. Standard methodologies include parametric, historical and Montecarlo). Special Problems in Commodity Risk Modelling Collecting data from illiquid markets Markets can be very volatile and instable Many non-market based factors (such as political events, and natural disasters) have a large effect on prices It is difficult to impossible to determine correlations between commodities -22-

Calculating VaR for Commodities Empirical Modelling In order to calculate the VaR, the historical prices of the commodities are considered. -23-

Calculating VaR for Commodities Empirical Modelling From the historical returns a distribution of the returns can be built -24-

Calculating VaR for Commodities VaR -25-

Calculating VaR for Commodities Example -26-

Calculating VaR for Commodities Key Required Information -27-

Calculating VaR for Commodities Key Information Flows -28-

Calculating VaR for Commodities Comparison of VaR Methodologies -29-

Calculating VaR for Commodities Comparison of VaR Methodologies -30-

COMMODITY RISK MANAGEMENT An Introduction to Commodities Pricing Commodity Contracts Calculating VaR for Commodities Governance and Controls in Commodity Firms

Governance and Controls in Commodity Firms Top Down Approach of Governance and Controls Best practice governance in Energy and Utility firms follows a top down approach. enables enables Board of Directors Discusses policies with respect to risk assessment and risk management. influences Senior managementlevel risk oversight committee (ROC) chaired by a chief risk officer (CRO): Development of strategic policy development and oversight influences The ROC, the CRO, and the corporate risk department: They are organized to support a risk management framework. enables Governance and controls: Enact organizational setup, policies, and procedures that support the company s business, establish SoD for front, middle, and back offices. enables By formalizing processes for front, middle, and back offices in this structure and implementing a written risk policy, helps minimize operational risk, including conflicts of interest. influences influences -32-

Governance and Controls in Commodity Firms Oversight Function The oversight functions follow a strategic, tactical, and operational corporate hierarchy. (This chart is not intended to depict an organizational structure, but rather to represent functional relationships and accountabilities.) -33-

Governance and Controls in Commodity Firms Three Office Structure The front, middle, and back offices - the three-office structure - has been patterned after that of the banking industry, with adaptations to the intricacies of the energy industry. Front Office...executes the company s risk taking and risk mitigation strategies. Frontoffice functions include deal execution, initial capturing and logging of a transaction s specific terms and conditions, and other transaction support roles such as scheduling and nominations. Executed transactions have the potential to expose the company to significant market, credit, liquidity, and operational risk. Therefore, an infrastructure of control separate from that of the front office is necessary to monitor market participation. Middle Office Middle office functions include assuring data integrity through deal validation and confirmations, analyzing and monitoring market and credit risks, validating price curves, and reporting risk data to management, in compliance with policies authorized by the ROC. Back Office The back office expands the control environment through balance sheet maintenance (reconciliations, accounts receivable [A/R], and accounts payable [A/P]), settlements, and financial reporting) -34-

Governance and Controls in Commodity Firms High-level Process Flow -35-

Governance and Controls in Commodity Firms Support Functions Support areas such as legal, internal audit, information technology, treasury, and tax play active roles in reducing the business risk profile of a trading and marketing operation. Legal Legal support must be skilled and knowledgeable in regulatory, contract, bankruptcy, and insolvency laws. Legal support is necessary when establishing new trade agreements or contracts and resolving counterparty non-performance events. Legal should review trade agreements and contracts for changes in market practices and applicable laws. Additionally, legal should evaluate transactions to determine whether they are permissible under applicable laws and regulations. Legal should also advise the credit risk department on applicable bankruptcy or insolvency laws and on the procedures necessary to ensure enforceable transactions and adequate documents. Internal Audit Internal audit s minimum responsibilities in support of the trading and marketing operations include annual financial and process audits and reviews. If the ROC engages outside consultants to perform process reviews, reviews should be coordinated with internal audit, and internal audit may be asked to lend support to those engagements. Internal audit should conduct routine audits of trading operations to ensure compliance with controls, policies, and procedures. IT Information technology (IT) is critical to trading and marketing operation in ensuring that systems are in place and function so that transactions may be accurately captured and reported in a timely manner. A company s IT policy supporting a trading and marketing operation must provide for: redundancies for networks and telecommunications failures; effective management of data (i.e., reliable availability, integrity, migration across systems, development, and maintenance of tools to obtain and utilize data); security of data and physical location; change control; disaster recovery; and business continuity plans. IT functions should be performed by personnel independent of the front office. Treasury Treasury s minimum responsibilities in support of the trading and marketing operations are cash management activities not supported by the back office. Critical activities include analyzing the company s liquidity position (including stress testing and contingency planning), developing interest rate curves, and hedging foreign exchange exposures. Tax Tax support of a trading and marketing operation requires knowledge of the tax laws of federal, state, and (if applicable) foreign governments. This knowledge extends beyond income tax to sales, franchise, excise, and other taxes. Tax support is necessary when seeking to enter new markets and to trade and market new products, including new types of financial instruments. Tax support should determine the effect of changes in tax laws. This group also determines the tax effect of transactions (including determining the most efficient tax structure for transactions). Tax support should also develop hedge identification procedures that meet tax laws and regulations. -36-

Governance and Controls in Commodity Firms The Deal Life Cycle The processes performed by energy trading and marketing companies center on execution, validation, risk management, and accounting of individual transactions; together, these processes can be labeled as the life cycle of a deal. Reporting Settlement & Accounting Close Deal Execution Deal Validation Risk Management Each of these can be further broken down in subprocesses, their objectives and controls & key reports. -37-

Governance and Controls in Commodity Firms Risk Management Sub Processes Daily Risk Monitoring, price curve validation, risk control and analysis and credit risk management are considered to be the risk management processes in the deal life cycle of a commodity firm. Daily Risk Monitoring Each day the middle office ensures that positions are captured accurately and risks monitored. It begins with a review of the risk reports to assess the activity from the previous trading day, continues with monitoring positions, and concludes with close-of-business lockdown to close system activity and prepare the risk reports for processing. Price Curve Validation Price curves are the primary driver of portfolio valuation, and it is essential to ensure the accuracy of the prices. As such, price curve validation is a key control performed by the middle office, which should independently obtain market prices and verify the accuracy of the forward curves for both market and non-market years. The risk control and analysis process consists of verifying the MTM valuation, calculating daily P&L, reconciling the P&L, calculating risk measures such as VaR, EaR, and CFaR, performing sensitivity analysis, performing stress testing, analyzing liquidity risk, and calculating any other risk metrics. Risk Control And Analysis Analyze and set a limit on the amount of activity the company is willing to transact with that counterparty, based on risk tolerances. Later the exposure should be monitored. If there is an overdraft, the credit department should verify and then notify CRM and front-office senior management so that a corrective action can be sought. Portfolio analysis is best practice, as well. Credit -38-

Governance and Controls in Commodity Firms Risk Management Process - Daily Risk Monitoring Each day the middle office ensures that positions are captured accurately and risks monitored. Objectives Ensure that positions are captured accurately and market risk can be continuously monitored. Support the best practice of segregation of duties and risk control. Best Practices & Control Each morning, the middle office should verify that all overnight risk reports were generated and review the reports for completeness, outliers, and limit violations. Limit violations should be communicated to the head of trading and the CRO. The middle office must ensure that actions are taken to become compliant with defined limits. Throughout the day, the system should maintain real-time positions by commodity, pricing point, and time period. Positions should be recorded in trading books and aggregated at the business unit and corporate levels. Limit exposures should be monitored in real time as trading activity and curves are updated in the system. Limit violation notifications should be sent to management throughout the day. At the close of each day s business, the middle office should perform a lockdown, validating the updated curves and trades, locking down the system, and rolling the system date forward. The middle office should then initiate the close-of-business risk report run (including positions, MTM, P&L, and VaR). Reports Position reports. P&L reports. Limit compliance reports. MTM reports. VaR reports. -39-

Governance and Controls in Commodity Firms Risk Management Process Price Curve Validation Price curves are the primary driver of portfolio valuation, and it is essential to ensure the accuracy of the prices. Objectives Value transactions of the business using current market data and/or models. Ensure that forward price curves are reasonable and reflect reality. Ensure that curves are developed using sound methods approved by the middle office. Best Practices & Control The middle office should validate each forward curve daily. Curve validation should include reviewing curves for outliers. Validation is always performed by the middle office in both market and nonmarket years. Although the front office may be involved in the validation process, authority for validation rests with the middle office. If the front and middle offices disagree on the price curve, it should be marked to the price chosen by the middle office and later submitted for resolution by the CRO or his or her assignee, with input from commercial management. Reports Price discovery reports (broker quotes, lectronic trading platforms, data feeds). Price curve validation reports. Model testing and validation reports. Model user and technical documentation. For market years, inputs include broker quotes and transaction prices, along with models for extrapolation and interpolation. For non-market years, the primary inputs are models, which should undergo rigorous testing and assumption review. -40-

Governance and Controls in Commodity Firms Risk Management Process Risk Control And Analysis This process consists of verifying the MTM valuation, calculating and reconciling the P&L, calculating risk measures, performing sensitivity analysis & stress testing, analyzing liquidity risk, and calculating any other risk metrics. Objectives Standardize the types of risk measures and their method of calculation in a way that corresponds to industry best practices. Ensure that transactions are valued appropriately & Gain an understanding of where risks concentrations lie in the portfolio. Quantify the risks in the portfolio & Evaluate the profitability of an activity. Analyze the potential impact of changes in the market on the portfolio. Assess the return on the portfolio based on the amount of risk taken. Best Practices & Control Marking Transactions to Market On a daily basis and change should be adequately documented and explained by new deals, changes in reserves, roll-off of old deals, or changes in the Greeks. Should be calculated on both a nominal and a PV basis. Data: independent sources, or in-house prices should be adequately reviewed. Developing Market Valuation Methodology Appropriate bid-offer levels & Mid Market valuation should be adjusted for expected future costs Choice of appropriate market-based curves Option pricing should include market price, volatility curves and correlation curves. Calculating Profit and Loss Components of revenue should be measured regularly and in detail P&L should be calculated daily P&L should include cumulative month-to-date and year-to-date results Measuring Market Risk Consistent measures and comparison against market risk limits (VaR) Transactions containing embedded option exposures should be measured with Greeks Back-testing and stress testing methodology should include various levels and corresponding the relevant guidelines Reporting on a daily basis and on all different levels Liquidity risk and concentration risk should be managed additionally. -41- Reports Position reports. P&L reports. Limit compliance reports. MTM reports. Greek exposure reports. VaR reports.

Governance and Controls in Commodity Firms Risk Management Process Credit The credit process can be broken into establishing credit and limits, monitoring exposure and portfolio management. Objectives Establish credit tolerances for the company & Evaluate all counterparties that do business with the company and establish appropriate limits. Quantify the credit risks of the portfolio & Analyze the potential portfolio impact of changes to a counterparty. Protect the company against credit risk for counterparties with bad credit ratings, poor payment history, or risk of insolvency. Maintain credit exposures within acceptable parameters &Provide the means to react to changing market and counterparty conditions. Provide a sound internal control environment, with separation of duties between the front-office creation of a deal and the verification of the counterparty by the credit department. Best Practices & Control A corporate-wide credit policy should be established and approved by the ROC. This policy should provide guidance on risk tolerance. It should include processes for establishing and approving limits, methods for ensuring that contracts have adequate credit protection, and procedures for monitoring exposure, maintaining collateral, and obtaining exceptions. Ratings should be established for all counterparties, and appropriate limits (including concentration limits) should be set. Acceptable collateral should be negotiated up front and maintained throughout the duration of the contract. Before deal execution, contract terms should be reviewed and approved by corporate risk management to ensure that the credit risk can be managed adequately. Master netting agreements (including margining provisions) and multilateral clearing platforms should be used when possible to minimize credit exposure. Credit exposure by counterparty should be calculated and reported at least once a day. This should include A/R, A/P, unbilled revenues, and MTM gains and losses on all positions. New trades should be monitored throughout the day to ensure compliance with limits. Credit limit violations should be reported immediately to the CRO and the front office. At least twice a year, periodic reviews of limits should be performed to assess whether changes should be made. News articles, bankruptcy filings, legal actions, etc., should be monitored on a daily basis for all established counterparties. Appropriate credit reserves should be calculated and recorded monthly. -42- Reports Rating agency reports. P&L reports. MTM reports. A/R aging reports. Credit limit compliance reports. Credit VaR reports.

Governance and Controls in Commodity Firms Overview of Process in the Deal Life Cycle Processes and subprocesses across a deal flow for a typical energy trading and marketing company for front, middle and back office. -43-

Governance and Controls in Commodity Firms Policies and Procedures Risk Policies and Risk Control Operational Procedures are the primary governing documents. Risk Policy Risk Control Operational Procedures 1. Policy Introduction 2. Oversight Responsibilities and Organizational Structure 3. General Policy Statement Business objectives and strategies. Identified risks. Risk controls Trading products and approval. 4. Market Risk Management Market risk identification. Risk measurement. Risk limits, monitoring, and compliance. Valuation and model approval. Risk reporting. 5. Credit Risk Management 6. Non-Commodity Risk Management 1. Front-Office Processes 2. Portfolio Design and Management 3. Middle Office Processes Deal validation. Confirmation. Contract administration. Risk reporting. Risk analytics. MTM and valuation adjustments. VaR. Greek framework. Stress testing. Other risk measures. 4. Personnel Policies and Other Responsibilities 5. Limit Structure 6. Process to authorize exceptions. 7. Credit Risk Policy, Controls, and Limits -44-

THANK YOU! "This document is confidential and prepared solely for your information. Therefore you should not, without our prior written consent, refer to or use our name or this document for any other purpose, disclose them or refer to them in any prospectus or other document, or make them available or communicate them to any other party. No other party is entitled to rely on our document for any purpose whatsoever and thus we accept no liability to any other party who is shown or gains access to this document. Deloitte AG is a subsidiary of Deloitte LLP, which is the United Kingdom member firm of Deloitte Touche Tohmatsu ( DTT ), a Swiss Verein, whose member firms are legally separate and independent entities. Please see www.deloitte.ch\about for a detailed description of the legal structure of DTT and its member firms. -45-

Governance and Controls in Commodity Firms Drilling Down Board of Directors The board, which has oversight responsibility for the financial health of the company, must oversee trading and marketing operations. Responsibilities Establish appropriate board committees, with formal charters and director qualifications. Understand trading and marketing strategies and associated risk. Discuss guidelines and strategic policies that govern the process by which senior management and the ROC assess and manage risks. Understand the company s risk management objectives and risk tolerances. Discuss a strategic risk policy that establishes an overall framework for risk management. Discuss the company s major financial risk exposures and the steps management has taken to monitor and control such exposures.2 Establish scope and frequency for management reporting to the board. Review compensation policies to ensure that they are structured so as to avoid incentives for excessive risk taking (compensation policies are typically reviewed by a compensation committee). -46-

Governance and Controls in Commodity Firms Drilling Down Risk Oversight Committee Membership of the ROC includes, at a minimum, the CRO, CFO, and senior management. The ROC must develop guidelines required to implement an appropriate risk management control infrastructure. Responsibilities Review and approve the risk policy and oversee enforcement by corporate risk management and the middle office. Ensure that risk management objectives, risk tolerances, and limits are employed throughout the organization. Review and approve the risk management strategy proposals around each affiliate s business plan. Each proposal should be reviewed for strategic fit, risk exposure monitoring, and reporting and control requirements; Periodically review any risk management program approved in light of recent market changes, and ensure continued compliance with its established guidelines. (Perform a detailed review at least once a year.) Formulate risk management strategy and policy necessary for new product or market implementation. Require and review regular risk reports prepared by the corporate risk management department and/or the middle office. These must include, but need not be limited to, the following: Profits and losses (P&L), both realized and unrealized. Open positions. Limit utilization. Status of exemptions and exceptions. Credit utilization. Periodically engage an independent audit (internal and/or external) of risk control processes and procedures. Understand which trading activities are accounted for using mark-to-market (MTM) accounting and which using accrual accounting. Approve the level (from individual trader to front-office management) at which authority to conduct trades in both MTM and accrual books resides. Hold formal ROC meetings at least monthly. Standing agenda items should include, but not be limited to, current trading strategy, review of current exposure position, control requirements/enhancements, and review of counterparty credit exposure. Perform an annual review of trading policies and codes of ethics. This includes review of disciplinary actions upon violation of ROC policies and procedures. Review the infrastructure supporting risk management (human resources, analytical tools, reporting procedures, etc.) and ensure that it meets the requirements for risk oversight and compliance Review compensation policies to ensure that they are structured so as to avoid incentives for excessive risk taking -47-

Governance and Controls in Commodity Firms Drilling Down The CRO The CRO is a corporate officer position independent of the front office and reports to the ExB and BoD. Responsibilities Perform responsibilities delegated by the ROC. Conduct ROC meetings. Engage the ROC in discussions regarding events or developments that could expose the company to potential losses. Assess risks to the company in aggregate, by business unit, and by material business activities. Measure and report on the company s risk profile. Develop, recommend, and administer corporate risk management and /or middle-office processes and procedures. Research, develop, test, and implement risk measurement methodologies and models. Recommend to the ROC specific risk limits consistent with the company s risk management objectives, risk tolerance, and risk management policy. Provide direction to the internal audit group, facilitating independent audits of risk control processes and procedures. Evaluate proposed transactions with respect to their potential impact on the company s risk profile, consistency with risk management objectives and risk tolerance, and compliance with risk management policy. Develop and monitor the implementation of provisions to the risk management policy, and oversee other risk management processes and procedures established by this policy or otherwise by the ROC. Report to the board of directors and the ROC on the company s compliance with its risk policy and risk management in accordance with the risk policy. -48-

Governance and Controls in Commodity Firms Drilling Down Corporate Risk Management The corporate risk management department reports to the CRO. The department is responsible for implementation of, administration of, and compliance with the company s risk policy and risk management processes and procedures. Responsibilities Develop and review systems and controls to measure risk. Monitor compliance as required by the risk policy, including aggregation of risks across the company and review of the company s overall risk profile. Review and recommend market risk and credit risk limits. Develop risk measurement techniques. Review and recommend for approval, risk measurement calculation and standardized position methodologies. Review curve validation and stress-test results. Evaluate the effectiveness of the risk metrics employed. Oversee the model development, validation, and testing process to ensure that market and credit risks are accurately quantified. Recommend operational risk and business risk assessment guidelines. Review business unit returns relative to expectations and to the level of risk incurred. Assess valuation issues and perform or review analyses on the company s overall risks, using specialized stress tests and scenario analyses. Aggregate or consolidate risk measures into enterprise-wide market risk measurement. This includes reviewing the effectiveness of transaction processing systems and procedures relating to risk measurement and overseeing adherence to risk policies, procedures, and limits. Assess and recommend the allocation of resources necessary for risk oversight and compliance (i.e., human resources, analytical tools, reporting infrastructure, etc.). Coordinate and distribute independent market fundamental analysis. -49-

Governance and Controls in Commodity Firms Drilling Down The Market Risk Function The market risk function ensures consistency across the company, aggregates enterprise risk positions, and economically allocates quantitative and other analytical resources. Responsibilities Review and validate valuation methodologies, curves, and assumptions and develop risk measurement techniques. Review the effectiveness of transaction processing systems and procedures relating to risk measurement. Review daily risk reports prepared by the middle office. Produce all enterprise-wide market risk reports. Perform back-testing and stress testing of risk measures such as VaR, EaR, or CFaR3 at least quarterly. Perform exception, variance, and risk-adjusted return on capital (RAROC) analyses. Oversee adherence to risk policies, procedures, and limits. Evaluate and recommend appropriate measurement techniques for reserves. Participate, as staff, to the ROC and carry out committee requests. Participate in new product reviews. Aggregate or consolidate risk measures into an enterprise-wide measurement. Identify, assess, and inventory market risks in all business units; advise the ROC on risk issues. Assess the impact of new business opportunities, (new markets, assets, strategies, etc.) on the corporate risk profile. Develop and distribute independent market fundamental analysis. Review and approve market assumptions in significant new deals. -50-

Governance and Controls in Commodity Firms Drilling Down The Credit Risk Function To facilitate enterprise-wide credit risk assessment, measurement, and management, and to maintain efficiency, credit risk management is best performed at a corporate level and independently from the front office. Responsibilities Review and approve counterparties and transactions before execution in order to identify, measure, and price the associated credit risk. Perform due diligence on issuers of counterparty guarantees, ensuring that they meet minimum credit standards. Coordinate review and execution of all counterparty documents with the business unit s contract management group and the company s office of general counsel; negotiate directly with counterparties to ensure that credit risk is mitigated through contractual arrangements. Using internal and external information sources, monitor counterparty credit events and industry/market trends for potentially adverse effects on the counterparty s credit profile. Calculate and report to the ROC credit exposures, credit risk metrics, and other requested information. Report, as required by the risk policy, any credit risk limit violation, loss notification, or other exception to the limit structure. Administer collateral (i.e., margins, parental guarantees, letters of credit held or given). -51-

Governance and Controls in Commodity Firms Drilling Down The Front Office The front office executes the company s risk taking and risk mitigation strategies. The front office s functions include deal execution buying, selling, and hedging of physical commodities or financial instruments. General Responsibilities Seek ROC approval for participation in new products, markets, or services that meet the company s business objectives. Understand, sign, and comply with the ROC risk policy and all other company policies, including the company code of ethics. Maintain confidentiality of information used in trading and risk management. Report violations of company policies. Abide by any non-compete agreements. Develop and maintain documentation outlining standard procedures for conducting business. Set up and maintain physical contracts in the operations systems. Trading and Asset Management Ensure that traders have proper knowledge and understanding of the products they are authorized to trade. Understand and abide by ROC trading limits, authorized product rules, and restricted activities. Develop trading, hedging, procurement, and marketing strategies in compliance with ROC policy and procedures. Execute all authorized trading, hedging, and marketing transactions. Comply with all personal trading restrictions and limitations. Arrange for the exchange of physical commodities at/on the appropriate facilities (pipelines, plants, pools, etc.). Trade only in approved market forums (ICOs, power exchanges, electronic trading platforms, exchanges, etc.). Communicate the operational status of appropriate facilities (pipelines, plants, pools, etc.) to the organization. Deal Entry and Logistics Input transaction detail into deal-capture system in accordance with established procedures. Acknowledge daily trading activity. Work with the middle and back offices to resolve errors on a timely basis. Ensure accuracy of transaction terms (including difference between nominated and confirmed volumes) in the dealcapture system. -52-

Governance and Controls in Commodity Firms Drilling Down The Middle Office The middle office is responsible for maintaining the overall control environment and assessing compliance with the risk policy. The middle office provides a significant level of control and policing of the front office s activities Risk Control Responsibilities Confirm all appropriate transactions within established industry standards. Establish a rigorous process to insure that confirmations are sent and reviewed pursuant to contract terms. Errors should be resolved, and changes should be communicated to appropriate personnel on a timely basis. Validate all transaction details to the relevant risk management systems. Foster a cooperative error-resolution effort between front, middle, and back offices. Maintain appropriate transaction detail and acknowledgement records. Develop and maintain documentation outlining standard procedures for conducting business. Routinely check trader authority and reconcile that authority with the appropriate external counterparties, exchanges, brokers, etc. Lead and/or support risk systems and infrastructure development efforts. Provide staff support to the ROC. Maintain risk systems. Monitor compliance with policies, guidelines, and limits; report violations. Identify weaknesses and opportunities for enhancement in the control environment;develop solutions and implementation strategies. Approve and manage the trading book structure designed to accomplish both front- and back-office objectives. Monitor and ensure the appropriateness of intra-book trades. Risk Analysis Provide daily report of risk exposures (e.g., P&L positions and change drivers) to the ROC. Perform periodic backtesting and stress testing. Calculate MTM and risk metrics such as VaR, EaR, and CFaR of portfolios on a daily basis. Analyze and explain changes in the portfolio. Calculate and monitor position Greeks. Valuation Validate and model forward curves for all commodity exposures (market analysis). Access market quotes for MTM assessment. -53-

Governance and Controls in Commodity Firms Drilling Down The Back Office Back-office functions include processes such as accounting, invoicing, dispute resolution, check-outs, actualization, accounts receivable, accounts payable, tax reporting, financial reporting, and contract administration. Perform financial accounting and compliance. Responsibilities Comply with tax rules and make appropriate tax elections. Account for hedging and derivatives activities. Record realized and unrealized gains and losses. Reconcile general ledger and cash positions. Reconcile margin accounts. Implement tax-hedge accounting policies and other regulatory tax requirements. Develop and maintain documentation outlining standard procedures for conducting business. Invoice counterparties. Resolve billing disputes. Perform daily/weekly/monthly checkout with counterparties. Develop and maintain documentation outlining standard procedures for conducting business. -54-

Real World Examples 1. An Example Project: Commodity Risk in the Cacao Industry -55-

An Example Project: Commodity Risk in the Cacao Industry Introduction to the Project A large commodity trader has implemented an In-House developed model for calculating the Commodity Value at Risk. Requested a review of the model methodology and implementation Requested a review of the framework in which the model was implemented Value at Risk at the Commodities Company The Value at Risk (VaR) indicates the maximum loss within a given time horizon with a given confidence level in normal market conditions. According to good practices, VaR is normally complemented with stress tests, in order to assess the risk of extreme market scenarios. The main features of the VaR include: VaR is a measure of market risks (liquidity, credit, etc. not considered) VaR is an absolute risk measure (risk is quantified in absolute monetary terms, not as a deviation to some benchmarks) VaR is a static measure (it assumes a static portfolio during the time horizon of the analysis) VaR is an asymmetric measure (it only considers events with a an adverse impact on the P&L) The main use of the VaR include: Quantification, control and forecast of the market risks of products, portfolios or organizational units Quantification of the risk adjusted performance of products, portfolios or organizational units The main components of the VaR include: Time horizon, (i.e. the time period of the analysis) Confidence level (i.e. the probability of not surpassing the VaR value in the given time horizon) Risk factors (i.e. the market factors with an impact on the portfolio) Methodology (i.e. the algorithm for the var calculation. Standard methodologies include parametric, historical and Montecarlo). -56-

An Example Project: Commodity Risk in the Cacao Industry Objectives of the Review and Work Done Summary of objectives Review the Value at Risk (VaR) model design and suitability for its intended usage Review the reliability of the VaR model outputs Preliminarily review the overall commodity market risk framework, with particular attention to options and structure risks Scope Model design and suitability Output reliability Commodity market risk framework Scope and Work Performed 1. A thorough review of the model design, theory, framework for, and intended use of the model 2. Assessment of the chosen confidence level and time horizon -57- Work Performed 3. A review of the implementation of the model through a code review of the H-VaR model 4. A plausibility check of the outputs of the model through a comparison with a parametric var model 5. A review of the data collection process, review of historical data and a full reconciliation of the October positions of BC Sourcing 6. A review of the of the commodity market risk framework in the context of the GCRM Policy 7. A specific review of the preliminary concepts for the control of the structure and option risks and a review of the limit setting framework

An Example Project: Commodity Risk in the Cacao Industry VaR at the Commodity Trader- Example of the Group level Commodity Risk Report Group Commodity Risk Report December 2006 Net position (in mt) Limits 1) Aug 06 Sep 06 Okt 06 Nov 06 Dez 06 % of +/- Limit Cocoa short/long in B.E. 35'000 26'463 28'404 24'090 22'540 27'600 79% Bean differential 300'000 130'880 147'828 130'874 172'216 203'661 68% Arbitrage 80'000-60'746-64'810-75'090-79'200-79'917 100% Cocoa Butter 14'500-5'917-5'436-8'666-471 3'047 21% Cocoa Powder 5'000 3'031 3'894 3'665 3'940 4'697 94% Cocoa Liquor 5'000 999-150 -49 2'965 2'540 51% Dairy -50'000-12'790-18'102-25'814-21'980-15'275 31% Sugar & Sweetener 2) 80'000 31'310 119'621 128'246 103'735 101'533 127% Nuts 2'000-1'324-1'976-1'856-1'458-907 45% 1) Approved by AFRQC as of January 17 th, 2006 and valid as from February 1 st, 2006 2) Seasonality long limit in July and August with a gradual take-off path (-30'000 MT/month) until end of December In the limit Out of limit -58-

An Example Project: Commodity Risk in the Cacao Industry VaR at the Commodity Trader- Overview of Commodity Option Hedging Risk Analysis Option Risk Analysis Dezember 2006 CLOSING RATES OPTION SCENARIO P&L LIFFE NYBOT Volatility Scenarios Terminal month Terminal market n/a n/a n/a n/a n/a Strike n/a n/a n/a n/a n/a Implied call volatility n/a n/a n/a n/a n/a Terminal month Terminal market n/a n/a n/a n/a n/a Strike n/a n/a n/a n/a n/a Implied put volatility n/a n/a n/a n/a n/a Terminal month Terminal market n/a n/a n/a n/a n/a Strike n/a n/a n/a n/a n/a Implied call volatility n/a n/a n/a n/a n/a Terminal month Mrz 07 Terminal market $1'635 n/a n/a n/a n/a Strike $1'350 n/a n/a n/a n/a Implied put volatility 59.3% n/a n/a n/a n/a OPTION SCENARIO P&L Terminal market scenarios (kchf) -CHF 400 -CHF 200 Unchanged CHF 200 CHF 400-5.0% -168-22 1 2 2-2.5% -172-25 1 2 2 Unchanged -177-28 0 2 2 2.5% -182-32 -1 2 2 5% -187-36 -2 2 2 20 0-20 -40-60 -80-100 -120-140 -160-180 -200 P&L impact in kchfchf Delta (1) CHF 35 Vega (2) CHF -272 GREEKS per 1 CHF equivalent terminal market price increase per MT of beans per 1 % volatility increase 5% 3.75% 0.025 Volatility scenario 1.25% 0% -1.25% -0.025-3.75% -5% -400-300 -100-200 400 300 200 100 0 Terminal market scenario -200--180-180--160-160--140-140--120-120--100-100--80-80--60-60--40-40--20-20-0 0-20 1) Delta is the sensitivity of the options value to a 1 CHF equivalent terminal market price increase per MT. 2) Vega is the sensitivity of the options value to a 1 % price volatility increase. -59-

An Example Project: Commodity Risk in the Cacao Industry VaR at the Commodity Trader- Overview of Commodity Segments VaR Analysis VALUE AT RISK REPORT Dezember-06 BC Group 31.12.06 VALUE AT RISK COMPONENT VALUE-AT-RISK Component VaR Component % Scenario ES ES / VaR Ratio The 10 days VaR with confidence level 95% is: -14'373'021 CHF B.E. -8'924'437 62% 30.11.2005-17'513'913 1.96 EXPECTED SHORTFALL DIFFERENTIAL -2'082'071 14% 19.05.2004-3'754'345 1.80 BUTTER -412'323 3% 19.04.2002-567'304 1.38 The 10 days ES with confidence level 95% is: -22'279'954 CHF ARBITRAGE -7'741'694 54% 16.02.2004-12'508'679 1.62 The ES is 1.55 time bigger than the VaR. POWDER -552'411 4% 04.11.2003-842'196 1.52 CAKE -81'417 1% 27.02.2001-109'374 1.34 P&L SCENARIO NIBS -1'686 0% 09.02.2006-3'625 2.15 The scenario that triggers the VaR is: 27 February 2004 The P&L of the scenario is: -14'373'021 CHF LIQUOR -217'506 2% 23.01.2003-349'121 1.61 NUTS -354'185 2% 20.12.1999-479'034 1.35 SUG & SWEET -2'878'637 20% 07.04.2006-6'782'979 2.36 The scenario that triggers the UpVaR is: 15 August 2005 FLAVOR -0 0% 15.06.2001-0 2.32 The P&L of the UpVaR scenario is: 16'407'512 CHF EMULSIFIER -79'743 1% 11.04.2006-251'732 3.16 The UpVaR is 14% bigger than the VaR. OIL & FAT -410'875 3% 06.04.2001-957'404 2.33 DIARY -1'441'788 10% 12.09.2002-2'649'445 1.84 STATISTICS Sum of Component VaR -25'178'772-46'769'149 Mean 25'886 CHF Std. Dev. 10'570'438 CHF Skewness 0.7 Kurtosis 19.0 Diversification effect 43% 52% x x 12.01.2007 31.12.06 COMPONENT VALUE-AT-RISK -30000000-25000000 -20000000 VaR amount -15000000-10000000 -5000000 0 Sum of B.E. SUGAR & DIARY BUTTER NUTS CAKE NIBS Component SWEETENER VaR Components of the BC VaR -60-

An Example Project: Commodity Risk in the Cacao Industry VaR at the Commodity Trader- Model Structure of the VaR Limit Setting Framework Available equity to cover the group commodity price risks Available Equity AFRQC Board of Directors 1 2 Group VaR Limit (CHF) 3 Group VaR Limit - GCRC VaR Limit 5 Reserve (CHF) 4 GCRC GCRC VaR Limit (CHF) RRU Sourcing VaR (CHF) RRU Limits RRU Limits RRU Limits (MT) GCRM Limit Setting Policy: 1) AFRQC assesses the equity available and decides what is available to cover the Group commodity price risks 2) On this basis the BoD sets Group VaR Limit (in CHF). 3) The AFRQC may decide to implement additional Group VaR Sub limits 4) GCRC defines the level of the GCRC VaR Limit needed for the Group s normal business (in CHF). 5) If the GCRC VaR Limit is lower than the Group VaR Limit a Group VaR Reserve in CHF is created -61-

An Example Project: Commodity Risk in the Cacao Industry Sample Project Work - Analysis Performed Simple Comparison of VaR As part of the project the calculated Historical VaR (H-VaR) was compared to a simplified Parametric VaR calculation, this calculation was performed in Excel and Matlab LIFFE2 NYBOT2 Ivory Coast Bohnen GBP/CHF USD/CHF Mean -0.030% 0.006% -0.001% 0.001% -0.009% Stdev 1.940% 2.020% 1.73100% 0.472% 0.663% Correlation LIFFE1 100.000% 80.074% 99.942% -7.329% -0.629% NYBOT1 80.074% 100.000% 79.967% -4.832% -10.052% Ivory Coast 99.942% 79.967% 100.000% -7.437% -0.734% GBP/CHF -7.329% -4.832% -7.437% 100.000% 63.514% USD/CHF -0.629% -10.052% -0.734% 63.514% 100.000% Prices GBP USD GBP CHF CHF 31.08.2006 806 1420 850 2.43 1.23 Prices CHF 1958.58 1746.6 2065.5 Scenarios VaR 1214 1 10-10 0 Position H-VaR P-VaR Variation % Outright future 1803 1933-7% Arbitrage 1137 1214-6% Differential 97 134-28% Inventory 1822 1866-2% -62-

An Example Project: Commodity Risk in the Cacao Industry Sample Project Work - - Code Review of Historical VaR Model H-VaR Engine Code Check - Overview Stage 1: History 1.6 1. Control of the price time series through sample data check 2. Review of the interpolation procedure 3. Review of the price rebuilding procedure 4. Review of ordering and formatting procedures 5. Review of transfer of price time series within the model Stage 2: History Loader 1.6 1. Basic control of data import and export Macro function code and data loading procedures 2. Detailed review of return calculations 3. Detailed review of first derivative approximations for DIFF Stage 3: Position Loader 1.6 1. Basic control of the data export Macro function code 2. Review of position transfer into the VaR Engine 3. Review of the template format Stage 4: H-VaR Engine 1. Control of data in the VaR Engine 2. Control of H-VaR simulation procedure and Macros 3. Review of individual risk factor VaR calculation procedures -Differential ( DIFF ) -Arbitrage ( ARB ) 4. Review of entire portfolio VaR calculation procedures 5. Control of VaR and ES calculations 6. Control of Sub-Risk Factor Mapping 7. Review of time scaling -63-

An Example Project: Commodity Risk in the Cacao Industry Results- Assessment, Assurance and Recommendations Assessment and assurance X Seriously deficient Needs improvement Basically controlled Well controlled The suitability of the VaR framework for the intended usage was confirmed A positive assessment of the reliability of the Value at Risk Framework was given, limited by the extent of the procedures performed: 1. A review of the code, 2. A plausibility check of the model output, 3. A review of the data collection process, and 4. A full reconciliation of the October 2006 positions 5. Review of the Risk Management Policies Main recommendations Reasonable assurance on the model reliability can only be achieved by a back testing procedure, not yet in place. A back testing procedure consists in a comparison between the ex-ante risk quantification and the ex-post P&L realization. It was noted that the overall P&L and its components are not comparable with the total risk and the risk break down, thus preventing the comparison between potential losses (risk) and realized results (P&L). -64-

An Example Project: Commodity Risk in the Cacao Industry Results- Model Design and Suitability Gaps identified No significant gap was identified Recommendations As no major issues were identified for the suitability of the model none of the recommendations are presented in this presentation. Assurance Based on the scope of our analysis, we can confirm that the model is properly designed to reflect the commodity price risk in normal market conditions and in basic stress scenarios. The suitability of the VaR framework for its current intended usage was confirmed. The 95% confidence level and 10 day horizon of the VaR is suitable for the current application purposes. Assurances did not extend to the structure risk and option risk, which are not sufficiently covered with the VaR Framework. The Group Risk Manager is in the process of developing separate concepts and tools to properly quantify and control these commodity risks. -65-

An Example Project: Commodity Risk in the Cacao Industry Results - Output Reliability Gaps identified Two significant gaps were identified potentially affecting the model reliability: The lack of a back-testing procedure The lack of systematic controls to ensure the reliability of data from sources external. Recommendations Implement a back-testing to obtain assurance on the reliability of the model results and to obtain assurance that the limits set based on VaR are inline with the risk appetite. Align the P&L to the VaR, as this is a prerequisite for back-testing Review of sample risk data during some audit. Assurance To the extent of our analysis, reasonable assurance that the calculations performed by the model are basically correct was given. However, reasonable assurance regarding the reliability of the model results can only be obtained by setting up a back-testing procedure, currently there is no procedure in place. Reasonable assurance that the positions are properly reported was given, however assurance on the correctness of the positions delivered by the other units was not confirmed. -66-

An Example Project: Commodity Risk in the Cacao Industry Results- Commodity Market Risk Framework Gaps identified Overall commodity risk management framework is in development. The VaR framework is an important component of the overall risk framework, but only addresses the commodity price risk. The further pursuit of other commodity risk management tools and the finalization of policies and procedures is central to the solid and comprehensive development of the commodity risk management. Recommendations Finalize the option and structure risk concepts, in our view two points requiring management attention. Finalize and update the risk controlling and reporting procedures. Assurance The option and structure risks concepts, as reviewed in their current preliminary state, are developing in an appropriate direction. -67-

An Example Project: Commodity Risk in the Cacao Industry Results- Performance Gap Mapping 4.2.3 Position Reporting -68-

An Example Project: Commodity Risk in the Cacao Industry Sample Project Work - Analysis Performed The following table summarizes the issues addressed in the investigation along with the most important findings(for details on issues categorization, please refer to section 7.1). A complete description of all issues is documented in the section 4 (Process Review, Gaps and Recommendations) Title Description Signif. Ref Process / area VaR Framework Reliability Overall Commodity Risk Framework Alignment with P&L and Backtesting Position Reporting Commodity Risk Limits Risk Controlling and Reporting Reasonable assurance on the model reliability can only be achieved by a back testing procedure, not yet in place. A back testing procedure consists in a comparison between the ex-ante risk quantification and the ex-post P&L realization. Currently, we noted that the overall P&L and its components are not comparable with the total risk and the risk break down, thus preventing the comparison between potential losses (risk) and realized results (P&L). Main differences include the return period considered (VaR: 10 days, P&L: 1 month) and the FX result (not considered in the VaR but considered in the P&L). As no integrated trading system is in place, position data are delivered by the various business units to the Corporate risk controller in standard templates, and as a consequence no automatic data check is in place at central level. No gaps were identified for the risk position reporting of BC Sourcing, based on our process analysis and reconciliation work. Based on a previous work by the Internal Audit of BC of 2006, there are evidences that risk positions reported by ESC were not inline with their actual positions. BC is in the process of defining a limit framework for its commodity trading business based on VaR, on option limits, and in structure limits components. As this is a new concept, it is not integrated into the risk policies yet. Regarding the preliminary framework, it is our opinion that s quantification of the structure risk in CHF instead of in MT should be considered. Although no major gaps in the preliminary work reviewed have been identified, we classified this item as B because the finalization of a commodity market risk limit framework should be a major point of management attention. The current GCRM policy describes well the reporting and limit exceedence policies as well as the general framework for the commodity risk management. We noted that the risk policies do not address the risk controlling and reporting of the structure and option risks, as they are still in the development phase, and that there is no description of the break down procedure of the total VaR Limits to RRU Sourcing and to the other RRUs. Although no major gaps in the preliminary work reviewed have been identified, we classified this item as B because the finalization of a commodity risk controlling and reporting framework should be a major point of management attention. A/B B/C B B 4.2.1 4.2.3 4.3.1 4.3.2-69-