By Karim Blanc
In today's volatile markets, financial institutions are under intense pressure to analyze and control their risks. Global economic uncertainty, plus evermore extensive and complex regulation, means institutions have had to quickly adapt to measure and manage market, credit and liquidity risks in a consolidated, real-time manner across all instruments, portfolios, business lines and geographies. As well as providing transparency to shareholders and regulators alike, they must continue to generate revenue in intensely competitive markets.
Regulatory environment
The sheer volume of constantly changing regulations - Basel 2.5 and Basel III, Dodd-Frank, MIFID II to name a few - means that banks are expending large resources to firstly track the changes, and secondly, implement them. These new regulations often address many of the same issues banks have to deal with in managing their risks and adapting to the new environment, so there is some synergy that should make adapting to the new regulations easier.
However, because each one demands its own measurement and management methods and disclosures, and there are a huge amount of regulations, the investment to deal with them is large in spite of that synergy.
Currently, central clearing facilities are the major regulation change that is intended to bring stability to the financial system, and it could be interesting to see how this plays out in the future.
As well as moving regulation, company boards question risk taking more thoroughly and the risk function is seen as more critical to successfully navigating stormy seas. The responsibility of the chief risk officer has become heavier and the investment required to support the decision process increased or maintained at a time when much investment in other areas is being curtailed due to tough business conditions.
Regulatory impact on systems
These regulations have a significant impact on both the banking and trading books. From the banking side, for instance, liquidity and liquidity buffers must now be addressed by location, not just globally, and with tailored rules for each market. Liquidity in Basel III will force banks to go beyond what they have already implemented to manage risk better from a business perspective.
From the trading side, comprehensive liquidity pricing across activities, measuring the increasing impact that collateral management has on liquidity, and adapting to central clearing all needs to be done not just as a global risk measure at the enterprise level, but as something that is spread across all systems so liquidity pricing becomes available to each desk and each trader.
Dodd-Frank and related regulations already have a significant impact despite their complexity. Banks are starting to upgrade their infrastructure to prepare for more central clearing and further use of swap execution facilities, for example. This may lead to a more streamlined solution and seems likely to be one of the ‘big-items’ in terms of regulatory impact on systems.
Risk interplay and faster reaction times
During a crisis, there is increased correlation of risk as several factors interact with each other at the same time very quickly; equity markets can drop, sovereign risk rises, interbank liquidity dries up and credit spreads explode, and the software systems that support this have to bring together various models and data to show results from multiple risks.
Not so long ago real time was the preserve of the front office and risk managers were supposed to work with the previous day’s data. This no longer applies. Although the timescale of the two processes remain different, real time is becoming more important in credit, liquidity, and market risk assessment. Changes happen faster and risk management must adapt in order to bring value to the decision process and help the business navigate this environment. Effective risk management has always been a close interaction of all actors in the process but the pressure is now even greater because the stakes are so high.
Efficiency in risk management
The increased requirements of risk management come with a cost; systems need to be linked together, and users can end up with a brittle, fragmented architecture held together by many interfaces. This is stressed even more when real time updates, reliability and global coordination are required. Therefore, banks are aiming to make their infrastructure more efficient, integrated, and implement more straight-through processing (STP). This is the only way they can keep costs under control whilst achieving more from their risk systems.
Financial institutions can look to vendors that have a true enterprise-wide risk management solution covering both the banking and trading books and giving them the ability to accurately manage risks with a single view within their business.
Karim Blanc is director of risk solutions management at Misys plc