Buy-Side Technology
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The New Risk Management Tool Kit
Investors, not regulators, are driving risk technology spending
February 2, 2009
Struggling with brokerage failures, massive losses and widespread layoffs stemming from the financial crisis, buy-side firms are taking a renewed interest in counterparty and operational risk.
In the current environment, firms are "ripe for incidents of fraud and a breakdown of internal controls," according to Boston-based Aite Group. In a November survey of technology executives at capital markets firms, risk management and reducing costs ranked as the top priorities, according to the research firm. "Risk management is about to become the most prolific marketing term in capital markets technology," concluded Aite.
But the function is being approached in a far different manner than before the meltdown, when the buy side largely linked risk management to requirements like the Securities and Exchange Commission's short-lived hedge fund registration regime and federal rules mandating the archiving of electronic communications.
While hedge fund regulation now appears likely and federal rules continue to push e-archiving, risk management has taken on new urgency, with or without regulatory involvement. "No hedge fund is going to get money from an investor unless they have an effective risk management system in place," says Blaise Labriola, managing director of Altaira, a software developer based in New York and Salt Lake City.
As a result, "you will see very dramatic changes in risk management," says Labriola, whose company supplies the technology for the risk management offering of Linedata Services, a Paris-based trading systems provider. Funds will push "substantial money" toward the risk function in order to raise capital, he says. "Beefing up risk management is a selling point for them now. The market will dictate and demand the change in terms of hedge fund survival."
Old Models Ineffective
As old models prove ineffective, "there is going to be a shift in what people are looking at in terms of risk," says Labriola, adding that firms will move away from value at risk (VAR), a calculation designed to determine the amount of money that can be lost over a specific time in combination with a measure of confidence. "VAR does not really give you a true measure of risk," adds Labriola. "Markets do not behave normally."
Instead, he says, the focus should be on counterparty credit risk. According to Altaira, its risk technology aims to create a 360-degree view of a portfolio's risk, giving users the ability to create and run customized risk scenarios, shock portfolios and what-if scenarios. "We offer the ability to look at a complete portfolio, monitor it on a real-time basis, calculate position values and set up different stress scenarios so you can see where the risk and return is in your portfolio," says Labriola. "It is very hard to really drill down and see all the components of a security. It is very important to see the risk, but it is also important to see the return. VAR only gives you risk; this methodology allows you to actually see what is going on in your portfolio."
Roger White, managing director of Citisoft, a buy-side consultancy with offices in London, Boston and New York, agrees that risk technology has become a leading area of spending. "Risk management is top of mind with all our clients," he says. "Firms are allocating a large percentage of their budgets to risk management initiatives."
