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Waters Risk Compliance Oct10 Web


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Waters Risk Compliance Oct10 Web

  1. 1. October 2010 trading technologies for financial-market professionals Special Report October2010 Risk & Compliance Sponsored by: Cover_WatersSR_Oct10.indd 2 14/10/10 18:07:27
  2. 2. SYBIEOM05301 CM_Blink_v4_Ad_WAT_OL.indd 1 10/7/10 10:48 AMUntitled-2 1 11/10/2010 15:59
  3. 3. O f all the business processes exposed by the recent financial 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 finger of blame in their direction is as senseless as it is unwarranted. You see, prior to financial crisis—which for all intents and purposes is as close to the perfect storm as the financial 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 significant 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 sufficiently well-documented in the pages of most financial 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 deficiencies 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 firms 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 reflect up-to-the-minute changes in the market—aiming for that end point is an exercise in futility. ■ Editor-in-Chief Victor Anderson tel: +44 (0) 20 7484 9799 Online and US Editor Rob Daly tel: +1 212 457 7781 News Editor Anthony Malakian Deputy Editor, Buy Side Stewart Eisenhart Deputy Editor, Sell Side Michael Shashoua European Reporter Sitanta Ni Mathghamhna Graduate European Reporter Faye Kilburn Head of Editorial Operations Elina Patler Contributors Max Bowie, Editor, Inside Market Data Tine Thoresen, Editor, Inside Reference Data Jean-Paul Carbonnier, Deputy Editor, Inside Market Data Publishing Director Lee Hartt tel: +44 (0) 20 7484 9907 Commercial Director Jo Garvey tel: +1 212 457 7745 European Commercial Manager Ashley Snell US Business Development Manager Melissa Jao US Business Development Executive Chadi Antonios European Business Development Manager Robert Alexander Senior Marketing Manager Pedro Gastal Design Team Rob Cuthbertson and Lisa Ling Subscriptions Manager Stuart Smith tel: +44 (0)20 7968 4634 Subscriptions and Customer Service e-mail: tel: +44 (0)845 155 1846 tel: +1 212 457 7788 Chief Executive Tim Weller Managing Director Matthew Crabbe Head Office Haymarket House 28-29 Haymarket London SW1Y 4RX, UK tel +44 (0)20 7484 9700 fax +44 (0)20 7930 2238 Incisive Media US 120 Broadway, 5th Floor, New York, NY 10271 tel (212) 457 9400, fax (646) 417 7705 Incisive Media Asia 20th Floor, Admiralty Center, Tower 2, 18 Harcourt Road, Admiralty, Hong Kong, SAR China tel: +852 3411 4888, fax: +852 3411 4811 Incisive Media Customer Services c/o Optima, Units 12 & 13, Cranleigh Gardens Industrial Estate, Southall, Middlesex UB1 2DB, UK tel +44 (0)870 787 6822 fax +44 (0)870 607 0106 e-mail: Sell Side Victor Anderson, Editor-in-Chief Waters (ISSN 1068-5863) is published monthly (12 times a year) by Incisive Media. Printed in the UK by Wyndeham Grange, Southwick, West Sussex. ©Incisive Media Investments Limited, 2010. All rights reserved. No part of this publication may be reproduced, stored in or introduced into any retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the copyright owners. A Study of Inadequacy WatersSR_Oct10.indd 1 14/10/10 18:28:26
  4. 4. 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 Indata Launches Performance Monitoring Application David Csiki Indata Information Mosaic Launches Asset Surveillance Tool Post-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 efficient 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 flows; an interface is also provided for users to check their GIPS certification. Sonya Thadhani, chief investment officer at California- based asset manager Bailard, says in a statement her firm uses iPM Performance for more efficient 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. ■ WatersSR_Oct10.indd 2 14/10/10 18:29:15
  5. 5. News Expanding its product set of financial 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 financial 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 FRSGlobalUK-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 Mangement Portfolio 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. ■ October 2010 SocGen Changes Timeline for Valuations Société 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 WatersSR_Oct10.indd 3 14/10/10 18:29:25
  6. 6. William Neuberger, Managing Director, Global Co-head of MORGAN STANLEY Electronic Trading North America’s largest gathering of financial markets CIOs and CTOs December 6, 2010 New York Marriott Marquis Hotel, New York City Waters USA is the most comprehensive congress for financial IT, which brings together CIOs, CTOs, and decision-makers from leading financial institutions to discover the latest innovative business and technology solutions whilst networking with their peers. HOSTED BY: FREE for qualified end users LEAD SPONSOR:Hear from these leading practitioners: Stephen Norman, CIO, Global Banking & Markets, ROYAL BANK OF SCOTLAND Peter Richards, Managing Director, CTO, Global Head of Production & Infrastructure Management, Investment Banking Group, JP MORGAN Peter Kelso, Managing Director, Global CIO DB ADVISORS & Global CIO DEUTSCHE INSURANCE ASSET MANAGEMENT Michael Radziemski, Partner, CIO, LORD ABBETT & CO Gerald Le Donne, Chief Architect for One Bank, CREDIT SUISSE Madge Meyer, Executive Vice President and Head of Global Infrastructure Services, STATE STREET Brian Fagen, Managing Director, Head of Equities Electronic Trading Distribution, BARCLAYS CAPITAL PRESENTATION SPONSOR: PANEL SPONSORS: Subhra Bose, CTO, Alternative Investments, CREDIT SUISSE Michael Denzler, Director of Electronic Trading Services, CITIGROUP Garrett Nenner, Managing Director Global Markets, MOMENTUM TRADING PARTNERS, LLC Michael Mollemans, Head of Electronic Trading Sales, DAIWA CAPITAL MARKETS AMERICA For sponsorship opportunities, contact: Jo Garvey T: +1 212 457 7745 E: To register, please contact: Lukas Hall T: +44 (0)20 7484 9861 E: TTMDWTGWUSA10_AD206x276-1.indd 1 14/10/2010 16:53 Untitled-2 1 15/10/2010 12:50
  7. 7. Open Platform October 2010 As a result of the credit crisis and the ensuing market downturn of 2008 and 2009, there has been fresh assessment of the efficacy of previous financial innovations and the regulations governing the global financial services industry. The questions at hand are: What’s next? And how? By Sinan Baskan C learly, in the wake of the financial crisis,themarketstructurehaschanged 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 financial systemwithmoreglobalreachandinterdepend- 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 financial 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 Positions New 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 efficiently would be able to reliably measure risks to invested capital and to the balance sheet; what has proved to be difficult—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 difficult 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 efficient pricing mechanism for assets, including capital. When fiscal and monetary policy for consideration other than preservation of pricing efficiency 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 financial markets serve the economy by efficiently 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, diversification 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 efficiencies, 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 financial markets and investors need a clear set of principles and structure first before market dynamics can become the driver for recovery. ■ Sinan Baskan is senior director, global finan- 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 WatersSR_Oct10.indd 5 14/10/10 18:29:32
  8. 8. Special Report Risk & Compliance 6 October 2010 Roundtable Rethinking Risk Management Of the all the business processes to have undergone a radical rethink in the wake of the financial crisis, risk management is the most prominent. Prior to the credit crunch, both buy- side and sell-side firms’ 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. WatersSR_Oct10.indd 6 14/10/10 18:30:27
  9. 9. Roundtable October 2010 What are the challenges facing financial institutions in developing a cross-asset, firm-wide view of their risk exposure? Shaun Waters, product development, Bloomberg Sell-Side Execution and Order Management System (SSEOMS): A significant challenge to managing cross-asset risk exposure is that firms 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 firms 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 firms. Without transpar- ency into your exposure across derivatives, foreign exchange (FX), and securities-lending, collateral pools will not be used efficiently. In this way, the industry has a long way to go to employ the mecha- nisms to help firms make the most efficient 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 financial institutions face in developing a cross-asset, firm-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 financial 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 financial institutions, data from numerous front-office trading systems typically flows into a cen- tral warehouse for the purpose of firm-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, firm-wide view of exposures? What most firms want to do when aiming to achieve this is to have consistency of modeling and valuation across different areas of the firm 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 classified, 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 firm-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 firms specializing in this, and smaller managers can outsource their compliance functions to these providers. The larger firms 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 specifications and what they are looking for.” Michael Levas, Olympian Capital Management Q Michael Levas Olympian Capital Management WatersSR_Oct10.indd 7 14/10/10 18:32:04
  10. 10. it’s time to know what we don’t know. A DTCC | Thomson Reuters Company Business dynamics have changed. Pressures around greater transparency have increased. And it is no longer an option not to know your counterparty risk exposure. At Omgeo, we provide robust tools that enable firms to gain precise, timely insights into their collateral needs, allowing them to accurately measure and respond to risk while optimising capital. With Omgeo CrossCheck® for portfolio reconciliation and Omgeo ProtoColl® for collateral management, you gain a holistic view into your exposure, including OTC derivatives and beyond. The result? Transparency across portfolios, efficient use of collateral and confidence to make even better business decisions. After all, knowing is everything. Omgeo. All together now. To learn more, please visit C M Y CM MY CY CMY K Untitled-2 1 15/10/2010 12:44
  11. 11. 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 final 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 financial institution faces in developing a cross-asset, firm-wide view of their risk exposure. First, the majority of financial institutions have multiple order management and trading systems, so accessing risk across these platforms is no easy task. These firms 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 firm 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 firm-wide, real-time view of the risk is very difficult to achieve. A further complication would be for those financial 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 difficult 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 firm-wide cash position. Sinan Baskan, senior director, global financial 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, firms 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 definitions, 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, firm-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 specific 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 financial services firms 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 firms and vendors are implementing tools to proactively manage liquidity risk. The industry is working together to provide information and develop applications for firms 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 October 2010 Q Eileen Dignen Managing Director Banking Initiatives & Accounts Swift Tel: +1 212 455 1800 WatersSR_Oct10.indd 9 14/10/10 18:32:24
  12. 12. (VaR) limits are increasingly being set and monitored by compli- ance officers, even at smaller financial institutions. Sinan Baskan: The recent upheaval in regulatory and political focus has undeniably had a significant 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 firms with significant 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 firms’ capacity to ensure that they are not only cost-effective, but also limits their ability to construct specifically tailored internal policies to protect their customers. John Burchenal: Prior to the “Fall” of 2008, compliance was primarily driven by internal factors. Financial firms created policies and procedures to comply with the existing regulatory framework and firm-specific 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 financial firms. The resulting Dodd–Frank Wall Street Reform and Consumer Protection Act creates a host of new compliance and regulatory requirements that will force financial firms 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 officers. 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 officers and chief risk officers 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 firm 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 five years ago when capital was quite cheap and plentiful and firms weren’t constrained by the levels of regulatory capital, now capital is scarcer and it’s being made more expensive as firms need to hold more of it. Firms are, therefore, finding 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 conflict 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 financial 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 firms 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 fluid. Special Report Risk & Compliance 10 October 2010 “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 Management SunGard Adaptiv Tel: +44 (0)208 081 2000 WatersSR_Oct10.indd 10 14/10/10 18:32:55
  13. 13. 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 efficiency 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 first place before their hands are forced. Eileen Dignen: Compliance functions within financial firms are being driven by internal and external factors. External factors may take priority such as pro- posed regulations drawing firms’ 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 firms need to prioritize resources in order to respond to the proposed regulation. The resulting guidance will result in changes that may impact financial 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 firm’s “internal monologue,” providing guidance and implementing risk-adverse services that conform to internal policies. What technologies are available to firms trying to get as close to a real-time view of their risk exposure as possible? Sinan Baskan: The technology on which many firms 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 firms 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 defined, linked and maintained, regardless of source. Eileen Dignen: Swift provides messages for information reporting including intra-day and end-of-day cash movements, and confirmations 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 firm 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 firm 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 firms specializing in this, and smaller managers can outsource their compliance func- tions to these providers. The larger firms 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 specific 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 October 2010 Q Sinan Baskan Senior Director, Global Financial Services Industry Solutions Sybase Tel: +1 212 596 1150 Sinan Baskan WatersSR_Oct10.indd 11 14/10/10 18:33:01
  14. 14. Premium pickings Our brands have long been the choice for professionals within financial-market technologies. Our premium content from Waters, Inside Market Data, Inside Reference Data, Buy-Side Technology and Sell-Side Technology is now available to you via a multi-channel business intelligence platform with daily analysis and news to enable businesses to deliver better strategies with more efficiency than before. By integrating our five market-leading brands you will get: the industry’s most respected editorial teams under one web interface up-to-the-minute analysis and news – uploaded directly from our editorial desks easy navigation – articles linked by topic across all five brands free content from our extensive selection of special reports and webinars comprehensive news alerts delivering premium business content consolidated events and training calendar one community to network and interact with a multi-level premium subscription service to serve your company’s needs – individually, departmentally or globally Do you want to cherry-pick the most valuable content and tools for your company in minimal time? If you want to know in advance what you can gain from a corporate site licence to the entire Waterstechnology platform contact Premium content for financial-market technologies Trial today – visit TTMDWTGWTGID_ADA4-3.indd 1 10/9/10 15:48: Untitled-2 1 15/10/2010 12:47
  15. 15. people in from the technology sector to help them improve these functions according to specifications 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 firm 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 financial 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, financial 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 firms 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 firms 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 firm faster than any other risk challenge. How are the financial institutions and third-party vendors addressing this issue? Bob Shea: The definition of liquidity is very qualitative, which makes it difficult for financial institutions to measure. For example, most firms 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 firm’s liquidity risk at a firm-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 firm has. You can overlay where other sources of liquidity requirements might come from—for example, a Roundtable “A significant challenge to managing cross-asset risk exposure is that firms 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 October 2010 Shaun Waters Product Management, Sell-Side Equity & Order Management System (SSEOMS) Bloomberg Tel: +1 212 617 6812 Q WatersSR_Oct10.indd 13 14/10/10 18:33:29
  16. 16. 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 firms 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 find the liquidity to fill your customers’ orders across markets. On one side, you have traders moving to dark pools or using flash orders to reduce costs while finding 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 efficient 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 firm’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 firms acknowledge their operational shortfalls—shortfalls that have dire consequences if not remedied. In short, senior management must upgrade their skill set to include firm-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 finalized and considered approach to liquidity risk across regulatory boundaries, many firms 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 confidence 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), firms can use the liquidity risk impetus to enhance many areas of their business including other risk systems as well as front-office quantitative analysis, improved pre-trade risk, and even back-office 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 specified 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 Special Report Risk & Compliance 14 October 2010 “Recent events such as the Lehman Brothers’ collapse have brought counterparty risk management to the forefront at buy-side firms. The reliance of buy-side firms on their counterparties for valuations and exposure calculations is decreasing. Collateral remains the most used form of credit risk mitigation, though larger firms are using the credit default swap market as well.” JD Jayaraman, Bloomberg JD Jayaraman Product Development, Bloomberg Trade Order Management System (TOMS) Bloomberg Tel: +1 212 617 2674 WatersSR_Oct10.indd 14 14/10/10 18:33:59
  17. 17. Q for their business. Third-party vendors such as Bloomberg and Algorithmics provide a framework for scenario analysis and stress testing that specifically allow for stress-testing liquidity risk. Some vendors also provide behavioral and simulation models of cash flows 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 firm 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 flow of a margin call based on a unique identifier and stream of electronic messages, which provide the flexibility to track the lifecycle of the activity via a full audit trail. Bob Shea: A buy-side firm 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 firms 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 firms 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 firm 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 firm 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 October 2010 Bob Shea Bloomberg Asset & Investment Manager (AIM) Bloomberg Tel: +1 212 617 2496 WatersSR_Oct10.indd 15 14/10/10 18:34:25
  18. 18. 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 fit-for-purpose technology where the analytics can be moved to the data environment significantly improves a firm’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, firms 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 firms 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 firms. Two things need to be recognized from the buy-side perspective if there is to be any change. First, buy-side firms have traditionally responded to brokers’ demands for collateral. Now, buy-side firms are taking control and determining appropriate levels of collateral. Second, buy-side firms need to acknowledge that efficient 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 unified view into firms’ counter- party risk and exposure. Shaun Waters: The financial 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 specific order. There are many vendors that offer counterparty risk management that cover exposure, tracking error, counterparty and VaR, allowing firms 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 firms. The reliance of buy-side firms on their counterparties for valuations and exposure calculations is decreasing. Collateral remains the most used form of credit risk mitigation, though larger firms are using the credit default swap market as well. Buy-side firms 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. ■ Special Report Risk & Compliance 16 October 2010 “The biggest challenge facing firms 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 firms.” John Burchenal, Omgeo John Burchenal Managing Director, Market Growth Omgeo Tel: +1 212 855 1614 WatersSR_Oct10.indd 16 14/10/10 18:34:32
  19. 19. 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 ©2010 Bloomberg Finance L.P. All rights reserved. 40751631 1010 IT’S ALREADY ON YOUR DESKTOP. BLOOMBERG TRADING SOLUTIONS LOOKING FOR AN OMS? Untitled-2 1 11/10/2010 15:55
  20. 20. October 2010 Cover_WatersSR_Oct10.indd 3 14/10/10 18:07:47