Risk Management Evolves for Risky Times

In this excerpt from Wall Street & Technology, reporter Melanie Rodier discusses the growing demand by Wall Street firms for real-time systems and automation, quoting Tom Driscoll, Charles River’s Vice President, Sales and Marketing.

As the new presidential administration and regulators continue to try to pick up the pieces of the shattered U.S. economy, the heat is on financial institutions to make sure their risk management practices are fully aligned with rapidly changing economic and market conditions. For most Wall Street firms, this means a growing demand for real-time systems, particularly for the valuation of securities, and increased automation, according to experts.

One of the main issues financial firms are facing today is valuing their over-the-counter derivatives, according to Robert Park, CEO of FINCAD, a Surrey, British Columbia-based provider of derivatives analytics tools, who says firms increasingly are interested in getting independent valuations of derivatives positions. "Most of the assets being traded are Level 2 instruments for which there is no market quote available," Park explains. "So getting an independent valuation is one of the key concerns in the marketplace today."

Further, many valuation models do not consider counterparty risk, points out Tom Driscoll, VP, sales and marketing, Charles River Development. "Institutions once deemed quite solid are not," he observes. "That puts pressure on flexibility and the models to make assumptions that a year or two ago would have been quite outrageous but, given the current situation, are likely a much greater risk now. That counterparty risk and how valuations are done need to be more flexible." He adds, "There's a lot of pressure for firms to not use a standard model to look at risk and valuation."

Another variable in Wall Street's risk models is emerging regulations. Notes researcher Aite Group, "Change is upon firms whether they like it or not -- not only internally but with regulations, too.” As a result, stress-testing systems – not just for extreme market conditions but also for regulatory scenarios – are becoming increasingly important. "In more-robust systems, we will see some of these compliance tools incorporate randomly generated scenarios subjected to constraints," Aite predicts.

The bottom line, then, is that executives need to understand their own risk systems and what those systems are trying to say, Aite asserts. "A senior officer ... now has to go beyond [trading volume] and see what his concentration and exposure is, [trades] on the books… It’s one thing to be in business and make your assets under management grow, but another to not be held accountable to what they are. There has to be an increased knowledge base from senior folks. You can't get a free pass anymore by saying, 'Our risk people are dealing with that.' "