Waters Risk Compliance Oct10 Web

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Risk & Compliance

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O f all the business processes exposed by the recent fi nancial crisis as being woefully inadequate, risk management is top-of-the-list. But before the legions of risk mangers in buy-side and sell-side land take offense to this

assessment, I should add that pointing the fi nger of blame in their direction is as senseless as it is unwarranted.

You see, prior to fi nancial crisis—which for all intents and purposes is as close to the perfect storm as the fi nancial services industry is ever likely to get—issues like counterparty risk and liquidity risk were anything but industry-wide concerns. In fact, from a buy-side perspective, counterparty risk had historically always been a broker-related, or sell-side, consideration, which goes a long way toward explaining how and why signifi cant numbers of hedge funds were forced to close their doors when Lehman Brothers went belly-up, hot on the heels of Bear Stearns, which failed in March 2008.

The sobering risk management lessons played out in the wake of the banks’ spectacular failures have already been suffi ciently well-documented in the pages of most fi nancial journals, which means rehashing the recent past serves little pur-pose. What’s far more useful to our industry is assessing current risk management practices, focusing on developing the types of procedures that ensure that the defi ciencies of the past stay in the past.

In this respect, what has become patently obvious over the past 18 months is the realization that, as buy- and sell-side fi rms overcome their inertia and start moving toward managing their risk on a close-to-real-time basis across business units, asset classes and geographical locations, data lies at the heart of the chal-lenge. Managing risk in such a manner is the natural end point to which all risk professionals should aspire. And, even though that end point is still a long way off, it is nonetheless realistic and achievable.

But before we get carried away on a wave of pragmatism, even the most san-guine risk manager will concede that unless you can guarantee that all the data within your organization is clean, consistent and homogenized—and, perhaps most importantly, it is processed in close to real time so as to refl ect up-to-the-minute changes in the market—aiming for that end point is an exercise in futility. ■

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A Study of Inadequacy

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Special Report Risk & Compliance

In order to help asset managers comply with the US Securities and Exchange Commission’s (SEC) revised Rule 2a-7 requirements, JPMorgan has enhanced its regulatory reporting services for money market funds (MMFs). The upgrade “features a suite of stress tests, including: an increase in short-term interest rates; an increase in shareholder redemptions; a downgrade of, or default on, portfolio securities; a widening or narrowing of spreads between yields on an appropriate benchmark selected by the fund for overnight interest rates and commercial paper and other types of securities held by the fund; and a combination of events,” according to a release. The firm says that it is also planning to add futher stress-test scenarios for asset managers to see “how adverse market conditions can affect money market fund performance.” ■

JPMorgan Enhances Regulatory Reporting Capabilities for MMFs

Pricing and risk management software vendor Fincad has released its F3 analysis product, for the first time combining its Microsoft Excel interface and software development kit (SDK) for integrating its

models into third-party or proprietary applications, which provides deeper coverage of over-the-counter (OTC) derivatives than its existing analytics suite, and allows end-users to create support for

new derivatives on the fly. F3 does not yet contain the market data available in the current suite, leaving users to choose their own data sources, though the vendor will make this available at some time in future. ■

Fincad Unveils F3 Analysis Offering

2 October 2010 waterstechnology.com

Indata Launches Performance Monitoring Application

David Csiki Indata

Information Mosaic Launches Asset Surveillance ToolPost-trade automation solutions provider Information Mosaic has launched its new Asset Surveillance tool that provides a consolidated view of network and depository counterparty risk through a single user interface. According to the vendor, the product employs visualization and presentation tools to provide risk diagnostics and assessment, and uses a flagging system through SMS and/or email to alert users to custom-set parameters. Information Mosaic sells the product to custodians and institutional asset managers looking to provide risk transparency from portfolios to individual trades.

“When Lehman Brothers collapsed, it took many financial institutions not days, not weeks, but months to unravel

their exposure to the failed bank,” says John Byrne, CEO at Information Mosaic, in a statement. “Our clients are looking for new and innovative ways to help provide increased portfolio visibility to network managers, risk officers and clients such as asset managers. It is this deeper level of transparency that will enable the markets to trade confidently once again.” ■

John Byrne, Information Mosaic

Portfolio management technology provider Indata has rolled out a new performance-monitoring capability, Indata iPM Performance, during the 2010 GIPS Conference held in San Francisco. Part of Indata’s software-as-a-service (SaaS)-enabled iPM Technology Platform, iPM Performance provides rate-of-return monitoring across levels including total portfolio, asset class, sector and composite.

The tool features real-time alerting functions for more effi cient return validations and corrective courses of action in the event of data errors. The new Indata offering also checks for portfolio violations of Global Investment Performance Standards (GIPS) rules regarding minimum asset levels and cash fl ows; an interface is also provided for users to check their GIPS certifi cation.

Sonya Thadhani, chief

investment offi cer at California-based asset manager Bailard, says in a statement her fi rm uses iPM Performance for more effi cient and automated data management. David Csiki, Indata managing director, anticipates greater client demand for technologies such as iPM Performance heading into 2011 in order to demonstrate sound data management, compliance and transparency to regulators and investors. ■


News

Expanding its product set of fi nancial compliance and risk management technology offerings, Wolters Kluwer Financial Services has acquired Brussels-based regulatory reporting and risk management software provider FRSGlobal. FRSGlobal’s product focus includes centralized multi-country risk and regulatory reporting; the acquisition adds coverage for operational and compliance risk and reporting to Wolters Kluwer’s product suite.

The vendor was previously owned by The Carlyle Group and Kennet Partners. Wolters Kluwer purchased FRSGlobal for an undisclosed sum. Wolters Kluwer claims the buyout will create the world’s largest compliance and risk management technology provider targeting fi nancial services, with more than 15,000 banking, insurance and investment management clients globally. FRSGlobal CEO Steve Husk, along with CFO and COO Serge Minne, will join Wolters Kluwer and manage FRSGlobal going forward. ■

Wolters Kluwer Snags FRSGlobal

UK-based data and portfolio analytics vendor StatPro is preparing to launch a new cloud-based portfolio analytics platform, dubbed Revolution, which will enable users to analyze portfolio risk and returns, generate reports, and publish performance data via a web-based terminal to improve management, marketing and regulatory compliance functions.

Revolution is currently in beta testing, ahead of a launch scheduled for early 2011, targeted at all types of buy-side firms, as well as custodian banks, administrators and prime brokers, which can white-label the solution to their clients.

“Portfolio analysis these days is as important as accounting. If you want to win business, report to your clients, understand what you are doing and

comply with regulations, you need to analyze your performance,” says StatPro CEO Justin Wheatley.

StatPro will initially populate Revolution with its own market data, covering half-a-million global equities, bonds, mutual funds and custom securities, and aims to

add data from other third-party sources. “We hope to persuade other data suppliers to provide their data on the platform so

clients can choose which data provider they want to use to price each asset. Our partnership terms are heavily weighted toward the partner to encourage them to do it, and it will be a flat rate for everyone. We take 20 percent, they take 80 percent of the data fees and they can charge whatever they want,” Wheatley says. ■

StatPro Readies Portfolio Analytics ‘Revolution’

Platform Computing, Sophis Team Up for Portfolio, Risk MangementPortfolio and risk management vendor Sophis is partnering with cloud management software provider Platform Computing. Through the alliance, the vendors have released a jointly produced product that will allow the banking, insurance and investment management sectors to distribute profit-and-loss (P&L) calculations, instrument pricing, risk simulations and Value-at-Risk (VaR), according to a statement.

The firms benchmarked their

solution at IBM’s Product and Solution Support Center (PSSC) in France and found that the test ran an historical VaR calculation on a multi-asset portfolio with 32,000 positions, which was representative of a true portfolio. The test, computing VaR calculations with 270 historical scenarios, took four hours using fewer than 300 nodes and fewer than 90 minutes using slightly over 800 nodes with no apparent limitation and linear scalability. ■

3waterstechnology.com October 2010

SocGen Changes Timeline for ValuationsSociété Générale Securities Servicing (SGSS) Asset Servicing is changing the time clients receive daily valuations, as part of a project aimed at ensuring the firm can deliver data to the right user at the right time, sibling publication Inside Reference Data has learned.

Clients previously received the valuation reports before 10 a.m., while going forward the reports will be sent before 7 a.m. Paris-based Philippe Rozental, head of asset servicing at SGSS, says one

reason for the move was that a European hedge fund manager requested the change to give it more time internally evaluate risk. ■

Philippe Rozental, SGSS

“Portfolio analysis these days is as important as accounting. If you want to win business, report to your clients, understand what you are doing and comply with regulations, you need to analyze your performance.”Justin Wheatley, StatPro


William Neuberger, Managing Director, Global Co-head of MORGAN STANLEY Electronic Trading

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Open Platform


As a result of the credit crisis and the ensuing market downturn of 2008 and 2009, there has been fresh assessment of the effi cacy of previous fi nancial innovations and the regulations governing the global fi nancial services industry. The questions at hand are: What’s next? And how? By Sinan Baskan

Clearly, in the wake of the fi nancial crisis, the market structure has changed fundamentally and the regulatory

supervision has grown less rigorous both by design in terms of deregulation, and as a con-sequence of reduced capacity and competence of the regulatory agencies. As the industry and policymakers look toward a new fi nancial system with more global reach and interdepend-ence, where systemic risks are to be managed much more successfully, a number of primary choices need to be understood and addressed collaboratively by the major economies.

Before deregulation and product innova-tion reshaped markets, investment, insurance and banking products aimed at retail inves-tors had separate universes and agencies with matching jurisdiction of oversight. In restoring the capacity to identify and manage systemic risks, are we to restore these distinctions again? In a room full of people mingling, we do not want to see sharp objects. Hence, we should remove them and make sure no one is hurt. We would not securitize, for instance, zero-down-payment loans at all.

Furthermore, the regulatory policy needs to decide how to view the investing public. Would the investor be regarded as a consumer of fi nancial services and products and be accorded protection as such? Most of the response to the crisis has been shaped by concern for potential impact on the small business and individual retail investor. Do we deem investors competent decision-makers who can be trusted to accept the consequences of their choices? If we are to accept this as the paradigm, then a “no bailout” policy should inform regulatory reform.

Clear PositionsNew practices in risk management would need to be based on fundamental precepts of regulatory philosophy that must have clear positions on questions such as these.

Risk managers in an environment where capital is priced effi ciently would be able to reliably measure risks to invested capital and to the balance sheet; what has proved to be diffi cult—in spite of advanced quantitative techniques and computing capacity—is to reliably quantify almost any dependency there is in the underlying data. It has proven to be especially diffi cult to separate noise in the data when there is lot of new data. We have always assumed that a free market would generate enough information so the market becomes an effi cient pricing mechanism for assets, including capital. When fi scal and monetary policy for consideration other than preservation of pricing effi ciency leads to distortions in the cost of capital, this shifts capital-allocation decisions away from capi-tal productivity and into arbitrage between traded instruments, inevitably resulting in rising volatility.

The fi nancial markets serve the economy by effi ciently allocating capital to productive uses for economic growth. The cost of credit and real returns on capital invested in real assets should remain in correlation. Under these cir-cumstances, it is possible to manage portfolio risks within assigned risk budgets—per asset class, for instance—and place limits on traded capital and controls on size and allocations.

The new risk management culture may not need anything different than to return to where quantitative risk analysis started, and rely on the very basics of portfolio theory, diversifi cation strategies, and asset-allocation models. What we may demand of a possible new regulatory regime is either one of two clear choices:• Restore free capital markets that are free of

legislative or policy-driven distortions and exceptions, and secure a market structure where capital is priced transparently. We would expect regulatory supervision to ensure that a degree of pricing power rests

with investors, and the aggregation of services for scale effi ciencies, which guards against high levels of concentration of capi-tal and product advantages in a few select institutions.

• Regulate institutions and products in dif-ferent sectors—investment banking, asset management, retail banking, insurance, and so forth—separately with respect to their relevant risk characteristics. We would expect restrictions on securitizations that might lead to the loss of correlation between the value of the underlying assets and traded instruments and accounting rules that ensure transparency in valuations and deal structure.

The answers at this point are not clear; the political will of governments and the compe-tency of regulatory agencies have not been tested yet to frame a more stable macroeco-nomic environment. The fi nancial markets and investors need a clear set of principles and structure fi rst before market dynamics can become the driver for recovery. ■

Sinan Baskan is senior director, global fi nan-cial services industry solutions, at Sybase, a Dublin, Calif.-based provider of software for managing and analyzing information using relational databases, analytics and data warehousing solutions.

A New Era of Risk Management




Roundtable

Rethinking Risk Management

Of the all the business processes to have undergone a radical rethink in the wake of the fi nancial crisis, risk management is the most prominent. Prior to the credit crunch, both buy-side and sell-side fi rms’ risk practices tended to run along business, regional and asset-class lines, and, in most cases, relied on overnight batch processing. But all that has now changed.


Roundtable


What are the challenges facing fi nancial institutions in developing a cross-asset, fi rm-wide view of their risk

exposure?Shaun Waters, product development, Bloomberg Sell-Side Execution and Order Management System (SSEOMS): A signifi cant challenge to managing cross-asset risk exposure is that fi rms have a tendency to manage different assets in different systems. The quality of data is also important. Without a robust set of market data being fed in, the model cannot achieve the goal of assessing the risk through event processing and analyzing the effect on the related exposure. You have to have a solution that will allow you to model the risk across the asset classes in real-time so that when a trade occurs, you can monitor and report on those positions instantaneously.

John Burchenal, managing director, market growth, Omgeo: The biggest challenge facing fi rms is bringing disparate processes and systems together for a collective view of exposure across asset classes. The data across the multiple risk systems, trading desks, and collateral desks within organizations needs to be standardized and normalized to produce meaningful and accurate results. Even more importantly, cross-product, asset-class netting of collateral is beyond the capability of most fi rms. Without transpar-ency into your exposure across derivatives, foreign exchange (FX), and securities-lending, collateral pools will not be used effi ciently. In this way, the industry has a long way to go to employ the mecha-nisms to help fi rms make the most effi cient use of capital across the board. If you can’t identify in a timely manner an accurate net exposure of all collateral, how can you expect to manage it effectively on behalf of the end client?

Michael Levas, CIO and managing member, Olympian Capital Management: Obviously, there are going to be many more controls. If they haven’t already been implemented they will be, in light of what’s gone on in the last couple of years. Everybody is concerned now with internal risk, counterparty risk, market risk, systemic risk, and so on. All of these issues are of paramount importance, and if those controls haven’t yet been implemented, they will be very soon.

JD Jayaraman, product development, Bloomberg Trade Order Management System (TOMS): There are a number of challenges that fi nancial institutions face in developing a cross-asset, fi rm-wide view of their risk. These include: • Risk aggregation: Consistent risk models and calculations across

different asset classes are important for proper risk aggregation. Large fi nancial institutions have a wide variety of models employed across various trading desks and risk departments, which makes it a challenge to unify. Modeling the correlation and the interaction of risk across various businesses and asset classes is a major challenge as well.

• Data quality: Garbage in garbage out—the quality of data is critical to the measurement and aggregation of risk. Data quality issues such as missing and erroneous data arise due to different representations of trades in different systems, necessitating complex fallback logic to rectify them.

• System integration: In large fi nancial institutions, data from numerous front-offi ce trading systems typically fl ows into a cen-tral warehouse for the purpose of fi rm-wide risk measurement. Integrating feeds in a reliable manner poses a major challenge.

Mat Newman, head of product management, SunGard Adaptiv: First, there is the methodology of what you are trying to do. What do you mean by a cross-asset, fi rm-wide view of exposures? What most fi rms want to do when aiming to achieve this is to have consistency of modeling and valuation across different areas of the fi rm and be able to aggregate those to get an enterprise view of risk in a consistent and valid way. It’s not just consistency of, for example, scenario generation—it’s also consistency of how different products are classifi ed, how they’re grouped, and how they’re valued, because it’s often the case that different areas of banks have different ways of managing these processes, which evolve and change over time. When you’re trying to get that fi rm-wide view of your risk you need consistency, which relies on common assumptions that are understood

“There are a number of platforms out there catering to real-time risk right now. There are compliance fi rms specializing in this, and smaller managers can outsource their compliance functions to these providers. The larger fi rms are developing—or already have in place—internal risk controls, and if anything, are bringing people in from the technology sector to help them improve these functions according to specifi cations and what they are looking for.” Michael Levas, Olympian Capital Management

Q

Michael Levas Olympian Capital Management


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by all so that the information coming from different business units is comparable and, therefore, can be aggregated. These elements start to argue for pulling the data into a central system and then re-valuing and analyzing it there, rather than having it decentralized and pushed out to different business units, while leaving the fi nal reporting and aggregation step to the central enterprise risk function.

Bob Shea, product development, Bloomberg Asset and Investment Manager (AIM): There are several challenges that a fi nancial institution faces in developing a cross-asset, fi rm-wide view of their risk exposure. First, the majority of fi nancial institutions have multiple order management and trading systems, so accessing risk across these platforms is no easy task. These fi rms typically rely heavily on technology resources to build data integration across the trading platforms, and then either build or buy enterprise-wide risk systems to evaluate the exposure. Even if the fi rm is successful in integrating the data, the quality of the data needs to be validated before it can be relied upon. This process can take hours or days to complete, so getting a true fi rm-wide, real-time view of the risk is very diffi cult to achieve. A further complication would be for those fi nancial institutions that have a truly global presence. Measuring their risk exposure at the global level is a tremendous challenge, due to the complexity of local markets such as Brazil, India and China.

Eileen Dignen, managing director, banking initiatives and accounts, Swift: Often, organizations only have a partial view of their cash. The chal-lenges include branches’ or subsidiaries’ frequency of reporting balances, while some accounts in the portfolio may not be reported on, making it diffi cult to generate a full view of cash available. This impacts borrowing and increases potential risk. To compound the problem, organizations in this day and age desire a dashboard to view all this information in one place. However, the data underpinning the information is usually housed in multiple systems across different balance sheets, giving a fractured view of information and the overall fi rm-wide cash position.

Sinan Baskan, senior director, global fi nancial services industry solutions, Sybase: As the concept has matured over the last 30 years, the systems supporting organizations’ risk func-tions have typically either been slowly enhanced through increased resources or implemented/replaced in a piecemeal fashion. The result is a plethora of disparate systems that often don’t share common data or analytical tools. As a result, fi rms face a demanding yet crucial task to begin consolidating, normalizing and aggregating the content and sources of risk information across the enterprise.

Many organizations today struggle with seemingly straight-forward transformations such as common data defi nitions, formatting, and timeliness of data collection and analysis. The complexity comes from the disconnected way existing systems were implemented, maintained and managed. Of course, while it’s important to begin rationalizing these systems to provide a cross-asset, fi rm-wide view, it’s also important to ensure the nuances needed to accurately manage different types of risk on products with very different characteristics from other asset classes is maintained. So, it’s not the risk engines themselves that need to be a key point of focus, but

the data that feeds them. Achieving one consistent, timely and understood view of data onto which any risk discipline, business line or geography can then apply its specifi c brand of analyt-ics and aggregation provides a clear foundation for future requirements and ensures consistency of analysis and reporting, removing many of the inaccuracies that can

occur through the current disparate risk analytical systems that are fed by their own local data silo.

To what extent are compliance functions within fi nancial services fi rms being driven by external

factors—e.g., regulators and investors—as opposed to internal ones?JD Jayaraman: Regulations such as Basel II and Basel III, and increased scrutiny by regulators and investors have impacted compliance functions directly by imposing rules such as market abuse rules, and indirectly through board directives. Pressure from regulators and stakeholders, and the increased focus on risk man-agement after the credit crisis have mobilized boards to improve risk management and compliance. Exposure and Value-at-Risk

Roundtable

“Financial fi rms and vendors are implementing tools to proactively manage liquidity risk. The industry is working together to provide information and develop applications for fi rms to be more agile and effective in this area, from implementing merged data models, liquidity tools, dashboards and other reports, to eliminating manual entry and spreadsheets as the main tools for liquidity risk management.” Eileen Dignen, Swift


Q

Eileen Dignen Managing DirectorBanking Initiatives & AccountsSwiftTel: +1 212 455 1800www.swift.com


(VaR) limits are increasingly being set and monitored by compli-ance offi cers, even at smaller fi nancial institutions.

Sinan Baskan: The recent upheaval in regulatory and political focus has undeniably had a signifi cant impact on compliance functions by increasing the cost of being in the business. However, this tends to split the market into two camps: Camp A contains the large fi rms with signifi cant resources, able to carry the necessary cost of meeting the external requirements while ensuring their internal requirements are not only met but continually reviewed and improved in line with senior management expectations. Camp B, unfortunately, consists of smaller organizations forced to resort to external, pre-packaged solu-tions to meet compliance requirements. This in turn reduces these fi rms’ capacity to ensure that they are not only cost-effective, but also limits their ability to construct specifi cally tailored internal policies to protect their customers.

John Burchenal: Prior to the “Fall” of 2008, compliance was primarily driven by internal factors. Financial fi rms created policies and procedures to comply with the existing regulatory framework and fi rm-specifi c rules. The compliance function was probably understaffed and was likely not represented on the executive leadership team. Then everything changed with the Bernie Madoff scandal, the Allen Stanford fraud case, AIG’s liquidity crisis and the collapse of Lehman Brothers, which combined to expose a dangerous and potentially disastrous weakness in compliance at many counterparty fi nancial fi rms. The resulting Dodd–Frank Wall Street Reform and Consumer Protection Act creates a host of new compliance and regulatory requirements that will force fi nancial fi rms to adopt tools and technologies that will provide the control and transparency now required in pre-trade, trade, and post-trade operations. Institutional investors who have heretofore taken a passive approach to these issues are now actively examining and benchmarking these practices as part of regular due diligence.

Michael Levas: There is great emphasis now on compliance and on appointing chief risk offi cers. I think there is going to be a mul-titude of new procedures—I don’t want to say improvements—that will be implemented across the board. I think you’ll see compliance offi cers and chief risk offi cers in places you never did before.

Mat Newman: Risk departments are becoming very focused on new regulations and complying with them, to the extent that they are hiring people whose job it is to keep track of these vari-ous new rules. The danger is that they are spending an increasing amount of time, not on what would be considered classical risk management, but in complying with new regulation. The “use test” principle says a fi rm can’t use one set of models to calculate regulatory capital and a different set of models when deciding to grant a loan or conduct some business. That sounds sensible because regulatory calculations shouldn’t be run in an ivory tower. But the problem is, unlike fi ve years ago when capital was quite cheap and plentiful and fi rms weren’t constrained by the levels of regulatory capital, now capital is scarcer and it’s being made more expensive as fi rms need to hold more of it. Firms are, therefore, fi nding considerably more pressure to optimize their regulatory capital. And so, if there is this use test in place that says the way I calculate my regulatory capital is the way I run my business and now one of the main drivers is to optimize regulatory capital, what do you do in a situation where there is a confl ict between what is good risk management and what is the lowest use of regulatory capital? These sorts of tensions need to be carefully managed.

Bob Shea: Over the past few years the level of scrutiny of fi nancial institutions by the regulators and investors with regards to managing compliance risk is greater than ever. For example, earlier this year in the US, the Securities and Exchange Commission (SEC) imposed changes to rule 2a-7, which forced money market fund managers to hold more liquid and higher-quality assets. Globally, we’ve seen restrictions on short-selling enforced by all the major regulatory bodies. Internally, a number of fi rms have imposed trading limits and approval processes to manage risk, but the majority of the growth we’ve seen in the function of compliance has been driven by new regulations and diligent investors. As seen most recently with the release of Ucits IV in Europe and the Frank–Dodd Act in the US, we should expect the regulatory environment to continue to be fl uid.



“What is meant here by real time is the sudden need to look at things in a different light and be able to do so in a fast and responsive way—it may not be a couple of seconds but it will be 30 seconds rather than, say, 20 minutes.” Mat Newman, SunGard Adaptiv

Mat Newman Head of Product ManagementSunGard Adaptiv Tel: +44 (0)208 081 2000www.sungard.com/adaptiv


Shaun Waters: In the sell-side equity space, the regulators have been the primary driver of change. The SEC has been swift in its proposals to bring transparency and effi ciency into the markets from the large trader reporting system (LTRS) proposal to the consolidated audit trail proposal. The May 6 Flash Crash cre-ated an environment where the regulators were forced to take a hard look at the way orders and trades occur in the market. The environment changed almost instantaneously after that, with the exchanges rolling out their “trading pause” initiatives within weeks of the event. On top of these unexpected events, the industry was forced to comply with the SEC’s adoption of the alternative uptick rule in November. This has forced brokers to react to the rules on the one hand, and also consider implementing measures to prevent these things from happening in the fi rst place before their hands are forced.

Eileen Dignen: Compliance functions within fi nancial fi rms are being driven by internal and external factors. External factors may take priority such as pro-posed regulations drawing fi rms’ attention in terms of complying with deadlines and new rules. The proposed Financial Crimes Enforcement Network (FinCEN) regulation is a good example of external factors impacting organi-zational decisions where fi rms need to prioritize resources in order to respond to the proposed regulation. The resulting guidance will result in changes that may impact fi nancial institu-tions. It is likely that new product development might be trumped by the need to invest in system updates to comply with regulatory guidance. However, internal compliance and audit departments can assist in tempering a fi rm’s “internal monologue,” providing guidance and implementing risk-adverse services that conform to internal policies.

What technologies are available to fi rms trying to get as close to a real-time view of their risk exposure as

possible?Sinan Baskan: The technology on which many fi rms have historically based their risk systems is now proving, in many cases, to be a hindrance rather than a facilitator. This is in part due to the reliance on batch data transfer and subsequent batch analytical processes that dictate an often overnight schedule. Today’s technologies such as complex-event processing (CEP) and

analytics-focused data management platforms such as Sybase RAP enable fi rms to not only move data in real-time but also perform analysis on the data as it moves, as opposed to the traditional method of putting the data “at rest” before analyzing it. This in turn means that organizations can now join multiple streams of granular raw data at the transaction level and aggregate results from existing systems without having to rip everything out and

start again. In addition, enterprise architecture tools are leading the way in helping organizations to begin to understand the vast amount of information they have within their estate and ensure it is well defi ned, linked and maintained, regardless of source.

Eileen Dignen: Swift provides messages for information reporting including intra-day and end-of-day cash movements, and confi rmations that can be integrated into risk and treasury applications used for

liquidity management, forecasting/dashboards, business intel-ligence/analytics reporting, and proactive risk monitoring.

Bob Shea: In order to achieve a real-time view of its risk exposure, a fi rm needs to either consolidate to a single order management system (OMS) for all assets or evolve to dynamic cross-systems integration for risk, leveraging ever-improving technologies, cloud computing, or complex-event processing. The fi rm using an OMS that can support global asset coverage and achieve real-time risk exposure across those assets will be at a strategic advantage over its competitors.

Michael Levas: There are a number of platforms out there catering to real-time risk right now. There are compliance fi rms specializing in this, and smaller managers can outsource their compliance func-tions to these providers. The larger fi rms are developing—or already have in place—internal risk controls, and if anything, are bringing

Roundtable

“Achieving one consistent, timely and understood view of data onto which any risk discipline, business line or geography can then apply its specifi c brand of analytics and aggregation provides a clear foundation for future requirements and ensures consistency of analysis and reporting, removing many of the inaccuracies that can occur through the current disparate risk analytical systems that are fed by their own local data silo.” Sinan Baskan, Sybase


Q

Sinan Baskan Senior Director, Global Financial Services Industry SolutionsSybaseTel: +1 212 596 1150sybase.com/capitalmarkets

Sinan Baskan


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people in from the technology sector to help them improve these functions according to specifi cations and what they are looking for. I think the continued emphasis will be in this area, as well.

Mat Newman: Different people mean different things by “real time,” so there are different cases to consider. For pre-deal check-ing I need to assess the impact of a new deal in a few seconds, and techniques such as Incremental Monte Carlo can be used to achieve this. At other times it’s not so much a case of real-time calculation as real-time responses to ad-hoc queries—something happens in the market and suddenly a fi rm wants to look at things in a different way. What they don’t want to have to do is re-run a full calculation to generate the results, because that takes a long time. So what is meant here by real time is the sudden need to look at things in a different light and be able to do so in a fast and responsive way—it may not be a couple of seconds but it will be 30 seconds rather than, say, 20 minutes.

JD Jayaraman: High-performance computing using graphi-cal processing units (GPUs) is gaining momentum for fi nancial applications. Grid computing technologies using low-cost Linux boxes have long been used to perform complex risk computations. Other promising technologies that can be utilized to get as close as possible to real-time risk are cloud computing, CEP and in-memory databases. Apart from computer technologies, fi nancial engineering advances such as a stress-matrix pricing methodology used by Bloomberg, greatly help in achieving near real-time risk management.

John Burchenal: Timely access to information is critical. Unfortunately, many fi rms do not have the systems in place to provide this data, and often times it can take days if not weeks to report net exposure to a counterparty. Proactive, cross-asset-class position management is key. Firms are just starting to look at their operations and are realizing that they have serious limitations by utilizing a highly manual and disjointed process. However, in some cases we are seeing fi rms proactively approach the issue by

opting for third-party providers or building in-house systems. These collateral management and reconciliation systems can now operate in near real-time. Through more regular reconciliation of position data, costly errors can be addressed sooner in the lifecycle, allowing the collateral management process to continue without interruption. These systems can provide relative certainty when it comes to exposure, counterparty risk and collateral availability.

Shaun Waters: Some interesting real-time technologies are being explored, such as the use of hybrid CPU/GPUs. Multi-core GPUs, traditionally used to manage video game graphics, are being used to handle complex calculations and algorithms simultaneously.

Liquidity risk has the potential to “kill” a fi rm faster than any other risk challenge. How are the fi nancial

institutions and third-party vendors addressing this issue?Bob Shea: The defi nition of liquidity is very qualitative, which makes it diffi cult for fi nancial institutions to measure. For example, most fi rms will classify 144a and private placements as illiquid, while in reality there is often enough value and volume with those particular assets to be deemed liquid. For fund managers, the measure of liquidity risk is typically driven by the mandates imposed by the funds themselves. These mandates are generally based on a number of determining factors regarding their assets, such as days to maturity or market volume depending on type. Third-party vendors such as Bloomberg, incorporating market data with the Bloomberg OMS compliance platform, are able to offer rule templates that monitor the fi rm’s liquidity risk at a fi rm-wide or fund level.

Mat Newman: The interesting thing over and above looking at liquidity as a risk in its own right, is how it’s integrated with other risks the fi rm has. You can overlay where other sources of liquidity requirements might come from—for example, a

Roundtable

“A signifi cant challenge to managing cross-asset risk exposure is that fi rms have a tendency to manage different assets in different systems. The quality of data is also important. Without a robust set of market data being fed in, the model cannot achieve the goal of assessing the risk through event processing and analyzing the effect on the related exposure.”Shaun Waters, Bloomberg


Shaun Waters Product Management, Sell-Side Equity & Order Management System (SSEOMS) BloombergTel: +1 212 617 6812www.bloomberg.com/solutions

Q


downgrade by a rating agency could trigger collateral calls from your counterparties.

Eileen Dignen: Financial institutions and vendors are imple-menting tools to proactively manage liquidity risk. The industry is working together to provide information and develop applications for fi rms to be more agile and effective in this area, from imple-menting merged data models, liquidity tools, dashboards and other reports, to eliminating manual entry and spreadsheets as the main tools for liquidity risk management.

Michael Levas: It depends—from a trading point of view, head traders will have to look at everybody on their desk and what they’re doing and how they’re doing it. If they question some type of position or strategy, there could be some in-depth dialogue between head trader and junior trader about what’s going on. We’re going to see more of that. Liquidity to me is of the utmost importance, and being able to control that and effectively manage that is one of the most critical issues facing a trader, portfolio manager or hedge fund manager on a daily basis.

Shaun Waters: On the sell side, liquidity risk includes the need to provide the liquidity by taking a position or the need to fi nd the liquidity to fi ll your customers’ orders across markets. On one side, you have traders moving to dark pools or using fl ash orders to reduce costs while fi nding liquidity. On the other side, the exchange operators are pushing back against the use of stub quot-ing by market-makers, who often sit away from the market and do not really provide any liquidity to the market. So, the market is currently wrestling with what is best for an effi cient marketplace and best execution.

John Burchenal: Liquidity risk is all about knowing your positions and being able to respond quickly to market conditions. Understanding what positions are collateralized, where that collateral stands, and the fi rm’s counterparty exposure are critical to mitigating liquidity risk. Where do you stand at any

given time, can you identify where your collateral is being used for rehypothecation purposes, are you under or over collateral-ized, and if so, by how much? It’s imperative in today’s market that fi rms acknowledge their operational shortfalls—shortfalls that have dire consequences if not remedied. In short, senior management must upgrade their skill set to include fi rm-wide counterparty risk management and take ownership and be accountable. Technology vendors are responding to this need by providing real-time risk exposure measurements and sophisticated stress-testing capabilities.

Sinan Baskan: Unfortunately, due to a lack of a fi nalized and considered approach to liquidity risk across regulatory boundaries, many fi rms are waiting before implementing a full solution. Some organizations have existing systems that they are attempting to scale to meet new internal and external requirements, but most are looking to a range of third-party offerings with a variety of backgrounds for the answer. These third-party solutions quite often are adaptations from other existing platforms such as asset and liability management (ALM) and therefore don’t necessarily provide the full confi dence needed to future-proof against further legislation and requirements.

The opportunity here, however, is huge. If properly imple-mented at the right level of granularity (at the transaction and product level) and with the right timeliness of data transfer (real-time), fi rms can use the liquidity risk impetus to enhance many areas of their business including other risk systems as well as front-offi ce quantitative analysis, improved pre-trade risk, and even back-offi ce settlement and valuation.

JD Jayaraman: Liquidity risk is a key consideration in the Basel III regulation. A liquidity coverage ratio to address short-term liquidity risk and a net stable funding ratio to address long-term liquidity risk has been specifi ed by Basel III. Financial institutions are required to maintain these ratios at above 100 percent; moreover, they are also expected to perform liquidity stress tests that incorporate shocks that cause adverse conditions



“Recent events such as the Lehman Brothers’ collapse have brought counterparty risk management to the forefront at buy-side fi rms. The reliance of buy-side fi rms on their counterparties for valuations and exposure calculations is decreasing. Collateral remains the most used form of credit risk mitigation, though larger fi rms are using the credit default swap market as well.” JD Jayaraman, Bloomberg

JD Jayaraman Product Development, Bloomberg Trade Order Management System (TOMS) BloombergTel: +1 212 617 2674www.bloomberg.com/solutions


Q

for their business. Third-party vendors such as Bloomberg and Algorithmics provide a framework for scenario analysis and stress testing that specifi cally allow for stress-testing liquidity risk. Some vendors also provide behavioral and simulation models of cash fl ows to assess liquidity risk.

Counterparty risk was traditionally an issue that only affected brokers prior to the recent market

meltdown. But, now it is a buy-side issue too. How is the buy side managing its counterparty risk and what technologies can be implemented to assist with this challenge?Michael Levas: As far as the technology aspect of it goes, you want to look to the fi rm with the most cutting-edge offering and that can deliver exactly what a manager needs. There’s a funda-mental aspect to this you need to look at, and there’s credibility and debt. All of these factors come into play when it comes to counterparty risk situations, so you’ll need to be able to look at this from various angles—whether they have a multi-asset trading platform, what their exposure is in a certain sector or asset class: Is it over or under? I think these are all issues you need to look at and understand before going forward. That’s the most critical challenge investment managers face regarding counterparty risk going forward.

Eileen Dignen: Improved collateral management is an area that buy-side institutions are looking at to better manage counterparty risk. A big pain point for the buy side is the lack of standardization around counterparty exchange information. Unlike the sell side, buy-side institutions by nature have to deal with their trading counterparts at the fund level. This, in return, results in sending and receiving multiple margin calls in multiple formats to differ-ent counterparties.

The exchange of information based on email and fax does not provide the required audit trail and tracking capability that the industry wishes to see. One way to resolve this problem is to

standardize the way the buy side communicates with multiple counterparties. This can be done by electronic message exchange based on industry standards and agreed upon by market partici-pants. Electronic messaging solutions like the Swift offering based on ISO 20022 standards not only comply with best practices proposed by the International Swaps and Derivatives Association (ISDA), but also provide a straight-through processing platform linking margin-call negotiations and agreements on the underly-ing collateral to the settlement activity. The industry needs a solution that will complete the upstream communication in an electronic format. This will allow buy-side and sell-side institu-tions to easily track the complete business fl ow of a margin call based on a unique identifi er and stream of electronic messages, which provide the fl exibility to track the lifecycle of the activity via a full audit trail.

Bob Shea: A buy-side fi rm typically manages its counterparty risk by diversifying its investments across multiple counterparties and by establishing exposure limits based on credit worthiness. The method by which the exposure is determined is generally a combination of the potential future exposure (PFE) as well as the settlement risk with the counterparty. The PFE is a method used to calculate the counterparty risk by determining the losses that would incur if that counterparty defaulted. There are several determining factors for the PFE. For example, a long-term credit default swap (CDS) deal will contribute a greater amount of counterparty exposure than a short-term deal because the default risk is greater the longer the deal is open. Another complexity revolves around the challenge that most fi rms face in aggregat-ing the exposure associated with open orders and unsettled transactions with the counterparty, along with the exposure obtained through securities owned from that counterparty. This is commonly referred to as measuring group exposure. Those fi rms with the technology and systems in place for calculating group exposure across multiple trading desks, while addressing some of the challenges discussed, will obviously fare better than those without.

Roundtable

“To achieve a real-time view of its risk exposure, a fi rm must consolidate to a single OMS for all assets, or evolve to dynamic cross-systems integration for risk, leveraging ever-improving technologies, cloud computing, or complex-event processing. The fi rm using an OMS that can support global asset coverage and achieve real-time risk exposure across those assets will be at a strategic advantage over its competitors.” Bob Shea, Bloomberg


Bob Shea Bloomberg Asset & Investment Manager (AIM)BloombergTel: +1 212 617 2496www.bloomberg.com/solutions


Sinan Baskan: Buy-side organizations with sound research functions are well-positioned to put in place in-depth and detailed counterparty risk solutions. Some may choose to rely on their asset-servicing providers; however, not being in control of a function as critical to the business as counterparty analysis could prove costly. As with other forms of risk management, the key is to ensure the right data platform is in place to allow any data to be analyzed at any time and therefore deliver the right analytics for the business. Using fi t-for-purpose technology where the analytics can be moved to the data environment signifi cantly improves a fi rm’s ability to gain sub-second warning using the same platform as it would for historical analysis. By ensuring these data and analytics bases are adequately covered, fi rms can prevent unwanted losses and anticipate unwanted exposure creating a more agile business.

John Burchenal: Even with new regulations on the near-term horizon, buy-side fi rms have largely not taken the collateral management process out of the shadows. They’ve started to acknowledge there is an issue but for the most part the infrastruc-ture has not been implemented, aside from a select few fi rms. Two things need to be recognized from the buy-side perspective if there is to be any change. First, buy-side fi rms have traditionally responded to brokers’ demands for collateral. Now, buy-side fi rms are taking control and determining appropriate levels of collateral.

Second, buy-side fi rms need to acknowledge that effi cient collateral management is asset management. Asset managers are not using collateral to its fullest potential on behalf of their clients; with a collateral process/system in place, they then have the ability to put it to its best use. As such, best-of-breed collateral management systems have emerged to manage collateral at the enterprise-level, across asset classes and provide a unifi ed view into fi rms’ counter-party risk and exposure.

Shaun Waters: The fi nancial crisis has certainly pushed coun-terparty risk management to the front of the line. The risk gaps that the buy side seems to be trying to address are market risk,

counterparty risk, and liquidity risk, in no specifi c order. There are many vendors that offer counterparty risk management that cover exposure, tracking error, counterparty and VaR, allowing fi rms to spend their resources on other business needs versus building a suite of risk tools in-house.

JD Jayaraman: Recent events such as the Lehman Brothers collapse have brought counterparty risk management to the forefront at buy-side fi rms. The reliance of buy-side fi rms on their counterparties for valuations and exposure calculations is decreasing. Collateral remains the most used form of credit risk mitigation, though larger fi rms are using the credit default swap market as well. Buy-side fi rms are instituting various measures such as counterparty limits, credit analysis involving legal and compliance departments, and better collateral and exposure man-agement. They are investing in collateral management systems and risk management systems to better manage their counterparty risk. The cost of building an in-house system for collateral and counter-party risk management is very high and warrants a careful return on investment (ROI) analysis. Several third-party vendor alternatives are available for managing counterparty risk. These vendor systems provide counterparty risk metrics such as current exposure, potential future exposure, expected and unexpected loss, and credit VaR.

Mat Newman: It used to be a bit asymmetrical—funds deal-ing with large broker-dealers took the view that they were the ones that were the credit risk and not the brokers. But that’s all changed. There are two main areas where the buy side is look-ing to improve risk management and use sell-side techniques: counterparty credit risk monitoring and collateral management. However, it will be different in scope, because the buy side will not need the same scale, breadth and speed of execution as the sell side. But they will need the same sort of overall framework in order to aggregate different types of business, to calculate their potential exposures, and to check those against credit limits. In collateral management we see a demand for optimizing collateral usage across different silos. ■



“The biggest challenge facing fi rms is bringing disparate processes and systems together for a collective view of exposure across asset classes. The data across the multiple risk systems, trading desks, and collateral desks within organizations needs to be standardized and normalized to produce meaningful and accurate results. Even more importantly, cross-product asset-class netting of collateral is beyond the capability of most fi rms.” John Burchenal, Omgeo

John Burchenal Managing Director, Market GrowthOmgeoTel: +1 212 855 1614www.omgeo.com


Bloomberg provides trading solutions designed specifically to address the trading, sales, portfolio and operations needs of buy-side and sell-side firms. Bloomberg Trading Solutions connects you to the world’s most extensive financial community, is hosted on a secure platform fully integrated with the BLOOMBERG PROFESSIONAL® service and your proprietary systems, and delivers global customer service at the local level.

For additional information type OMS <GO> on the BLOOMBERG PROFESSIONAL® service or visit http://www.bloomberg.com/solutions/

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