Beyond Dodd-Frank: The Dire Consequences of Inaction
Gaps and Solutions
Buy-side firms must be proactive in enhancing their risk infrastructure in the spirit of Dodd-Frank and take advantage of the technologies that are available to enable them to obtain the required overview. The consequences of the 2008 crisis were, and still are, widespread and damaging. To minimize the magnitude of 2008, and to prevent another Lehman Brothers-style crisis, a centralized single repository is absolutely crucial in order to fully address organizational gaps associated with credit and counterparty risks. When information on derivative positions is not centralized in one source, or an "investment book of record," it is impossible to get a full understanding of true positions.
Dodd-Frank also demands that firms conduct annual stress tests to assess how well they can absorb losses in the event of a wide range of negative shocks to the economy. Stress tests are one of the best risk management tools, as they force risk managers to evaluate the risks in detail.
Enhanced transparency is essential at all levels: products, portfolios, processes, costs, accounting and compliance. Straight-through processing (STP) between interdependent functions, such as risk and collateral management, will streamline operations and reduce risks. Collateral also must be calculated in real time; because in crisis situations valuations can be changing at an incredibly high pace, for risk exposure calculations to be useful they must be real-time. The premise of STP is simply the consolidation of workflows from the front-office trading operations all the way through settlement and accounting in the back office.
The Cost of Inaction
Buy-side institutions need to reassess their whole approach to risk management and holistically aggregate risk across all departments in one, consolidated system. This must be done, not only for the sake of regulation, but to ultimately regain investor trust. Following the 2008 crisis, investors grew wary of institutions' ability to manage their risk exposures. If a buy-side firm wishes to be competitive in this new market environment, rebuilding investor confidence in the firm's ability to manage risk should be an absolute priority.
The cost of inaction is too high for firms to ignore, and the time to act is now. Let's ensure the devastating economic collapse of 2008 was a thing of the past — not a prediction for our future.
Else Braathen is chief business consultant and risk management domain manager for SimCorp North America.
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