The operational divide: translating logistics to accounting

But while physicals have been financialized, they have not been mainstreamed into financial platforms. The challenges live in the market infrastructure and the data ecosystem that supports it.

Typical commodity markets have a very mature market infrastructure and data ecosystem, such as global exchanges like CME, ICE, NYMEX, and COMEX. In instruments traded there, there are lot sizes and position limits. Reconciliations with counterparties are straightforward. Furthermore, systems can provide robust reporting, as well as alerts before expiry to ensure clients trade out before ending up with an actual physical delivery.

Physicals, in contrast, do not have this same maturity. It’s also difficult to translate into a firm’s balance sheet or a fund’s NAV. The unique characteristics of physicals lie behind this challenge: types, units, grades, locations, and storage bring up questions that don’t show up on financial statements. For example, with crude oil, crude quality and carbon intensity create categories like “light sweet, medium sour, and heavy sweet,” with Platts listing 120 different streams based on their characteristics.ⁱ

To obtain real-time data, funds rely on a Commodity Trading Risk Management System (CTRM) to manage the complex lifecycle of buying, selling, and moving physical and financial commodities. They also identify, measure, and mitigate associated risks like price volatility, credit exposure, and logistics issues. These factors do not model easily in a hedge fund’s P&L or NAV.

The practical answer is a clear boundary between the operational system and the accounting system. Instead, central accounting systems should worry about only bare minimum data ingestion. Fund administrators receive basic position and quantity data inputs just for booking the trade. The pieces that translate for accounting tend to be limited to the location, the commodity, the commodity type, its grade (or equivalent for other types), the currency, and the quantity.