BlackRock Preps Technology Platform for Revamped CDS Sector
March 16, 2009
Asset management giant BlackRock is making changes to its technology platform and derivatives operations in anticipation of a newly transparent credit derivatives market.
The New York-based fixed-income specialist is tweaking the analytics and derivatives modules that feed its Aladdin investment system to accommodate new protocols for the standardized trading of credit default swaps (CDS), says Stephan Bassas, director of BlackRock's portfolio management group. The portfolio management, operations, legal, client and technology teams are participating in the effort, as the firm adapts to a sector that is being reshaped by regulatory and industry initiatives.
The Aladdin platform, which handles every transaction that passes through BlackRock, performs risk, portfolio management, compliance and processing tasks. BlackRock also offers the system to institutional investors.
Even a seemingly simple change to credit derivatives systems has extensive repercussions. Because the industry is moving to fixed 1 percent and 5 percent coupons for CDS trades, for example, the convexity and duration of the instruments will be affected, which will in turn require alterations to the assumptions embedded in risk management systems and cash-flow models. It's not necessarily just about populating two fields with terms denoting "100 and 500 basis points," says Bassas.
And every change has "second-round impacts" on the way firms value and model credit derivatives, he says, citing the International Swaps & Derivatives Association's move to a hardwired default cash settlement auction protocol and the trade group's decision to exclude restructuring as a payment-triggering credit event.
"We urge everyone in the CDS market to think of what the impact of the new cash flows linked to the CDS will be on the systems with which they've been monitoring their exposure and modeling their cash flows," says Bassas. "They are not neutral to any portfolio: Your cash-flow profile is changing."
Weathering the Storm
A major player in credit derivatives, BlackRock has weathered the financial storm better than most. Its assets under management decreased 4 percent in 2008, falling from $1.36 trillion to $1.31 trillion. But its assets actually grew 4 percent in the fourth quarter, rising from $1.26 trillion.
The firm has also played a role in the bailout of the U.S. financial system, helping alleviate systemic risk by managing assets for the government. The Federal Reserve Bank of New York in December picked BlackRock to manage a fund that purchases the assets linked to credit derivatives underwritten by the beleaguered American International Group. In June, AIG itself tapped BlackRock Solutions, the firm's technology and risk management subsidiary, to comb its portfolio for losses likely to be triggered by defaults of underlying assets in the swaps it sold.
Founded in 1988, BlackRock developed its technology and processing platform in-house, forming BlackRock Solutions in 2000 to provide it to external clients such as the California Public Employees' Retirement System and Freddie Mac.
Clean Architecture
Modifications to CDS systems can be complex. The best way to ensure they are done optimally and with few headaches is to have a clean architecture, says Bassas. BlackRock's database is integrated with analytics systems that can make customized queries depending on the product or scenario, he notes, which allows for accurately priced assets.
"Every single security and cash flow and any kind of characteristics are remodeled from scratch, so we control any aspects of the risk management of any individual security," says Bassas. "If the analytics of the CDS are changing from an OTC market, off-the-shelf type approach to something which is standardized, the only thing we have to do is model the instruments differently, tantamount to changing two parameters."
