Flaws in risk management have been stated as the major cause of the credit crunch.
A recent S& P Survey found that less than 2% of fund managers have adequate systems to manage risk, or in other words, 98% of fund professionals are unable to accurately predict, model and report financial risk
Based on the above stats, coupled with today’s tighter oversight, lower leverage and heavily regulated environment, what will the future risk management landscape look like ?
Building Blocks
Historically, the fundamentals of any risk management system was that it had to be practical, accurate and comprehensive and be able to provide the following Inter-Day functionality :-
• VaR across all positions
• Stress , Scenario testing across all positions
• Counterparty risk
• Inter Day covering position changes, market changes
• Extensible
As well as more importantly being able to calculate risk across multiple and sometime illiquid assets by :-
• Trader, desk
• Region / entity
• Asset class etc
This proved to be a significant undertaking for any organisation, requiring significant technology resources to manage the complexity, incurring prohibitive high costs.
Limitations
Many corporations are currently inhibited in their ability to fully grasp their risk exposure due to outdated or poorly integrated risk systems.
As a result of several large scale integration and acquisitions, several banks are being constrained by disjointed and duplicated IT systems which severely constrain their ability to identity and manage their true risk exposure.
Rear View Mirror
At the recent Trade Tech Architecture conference, Dr Tony Chau, Chief Architect J.P. Morgan described the current approach to Risk Management as a “Rear View Mirror Approach” that focused too heavily on where you have come from as opposed to looking ahead on where you are going.
This is akin to driving down a major road at speed, deciding to navigate by looking in your Rear View Mirror on where you have come from as opposed to looking ahead on what is approaching.
Forward Looking Work Flow
What is needed, is a forward looking view on Risk Management, where the intraday work flow would consist of the following :
• Multiple market environments, typically one per asset type e.g. futures, bonds, swaps
• Transaction are flowing real time into the risk system
• Multiple models and parameters are enabled – allowing the user to balance between accuracy and performance
• Run what if scenarios and strategies by tweaking market environment and parameters
The intraday risk work flow needs to be scalable and extensible to provide speed and flexibility for a new and improved approach to risk management.
This approach needs to be overlapped with pricing and back end functionality that is in use across the enterprise.
High Performance Chipset
In addition, due to the volumes of data required especially when dealing with historical data trends, there is a central need to leverage best of breed performance devices such as the high performance FPGA and GPU devices in order to be able to guarantee increased accuracy and timeliness of information in a near real time environment.
Looking Ahead
Only by moving to an improved risk management model, that provides a more accurate view of risk can an organisation truly migrate to a forward looking model and be able to predict, model and report financial risk in a near real time environment.
This will ultimately be a win-win solution for hedge funds, investors and regulators alike.
IAN ALDERTON
Email : ian@IanAlderton.com
Tel : +44 (0) 7702 777770
