Q&A: JP Morgan Reveals Most Effective Risk Management Processes
Risk management continues to be at the forefront of industry debates, particularly given a recent series of high-profile technology glitches, as well as new regulations and negative economic conditions. Wall Street & Technology recently sat down with Neal Goldstein, Managing Director of Electronic Execution, JP Morgan, and Co-Chair of the FPL Americas Risk Management Working Group, to discuss the latest FPL guidelines on risk and what they mean for industry efficiency.
WS&T: How have the financial crisis, current market conditions, new regulations and market incidents we’ve witnessed recently impacted the FPL risk guidelines?
NG: As a result of the Flash Crash in 2010, there was a great deal of interest in determining whether specific electronic orders, that may not have been properly evaluated for risk had been a contributing factor, and what pre-trade risk checks should be applied going forward. The events that occurred recently at Knight Capital are a good example of why both pre-trade risk checks and post trade aggregate position level risk checks are important. There has been an increase in regulatory scrutiny around exchange cut offs, and more questions around credit, relative to a market participant’s ability to settle trades and or satisfy margin requirements. Some of the previous regulatory rules recently implemented in the US, did not specify the prescribed mechanics on how to deal with credit. This is as an area where we expect to focus on for a subsequent release of the FPL Risk Management Guidelines.
WS&T: What does the broader adoption of the risk guidelines mean for industry efficiency?
NG: The real trend here is the recognition that effective risk management is not only about the individual order but also the cumulative effect of a client’s intra-day position on settlement exposure, credit and leverage. Risk Management is increasingly being viewed by clients as a key feature in any product offering. Demonstrating effective risk management is a competitive advantage. Now any sell side broker who has an offering has to demonstrate tight controls around risk. For large working algo orders, there is more emphasis being placed on intra-day market changes, including average volume, liquidity patterns and adverse or favorable price moves. What happens if a client puts out an order at 8am, and something happens in the market at 10am that the client isn’t aware of? With an algo you would halt the order and pause it and put it back on the desk.
WS&T: How is JP Morgan using the FPL guidelines in its own business and in what areas does JP Morgan see a need to apply new guidelines?
NG: When the latest guidelines were published, we decided to conduct an internal audit of our own products, using the guidelines as a benchmark. The result is that we identified a number of opportunities to improve our own product offering, and have upgraded our pre-trade risk checks accordingly. Many people [in the industry] conducted a similar exercise. To me, that was a great outcome. Another factor to consider is that while you may think you have working risk checks today, it is important to continuously validate risk checks as new functionality and application features are introduced. Validating risk checks has to be part of the whole release cycle.
In the futures and options space, there are a number of opportunities around intra-day margin checks, and message standardization for communicating risk thresholds between clearing broker and executing broker in support of the CFTC 1.73 regulatory initiative.
WS&T: Where are the current pain points for data management and risk management?
NG:NG: Electronic trading risk does not exist in a vacuum. At the large bulge bracket banks, clients often have trading relationships across multiple desks, and lines of business. The holy grail is to be able to quantify a client’s aggregate risk exposure across asset classes. This is particularly important if these risk checks may result in a kill switch being applied when a client’s trading positions exceeds a given exposure threshold. As an example, a client may have hedged a cash portfolio position with a futures position. Both positions would need to be factored to accurately quantify the net exposure.
To achieve this result, you need to have the ability for disparate systems across a bank, to publish open order and executed trade information to a central system. Some [firms] have invested heavily in this over a long period of time, and are more advanced than others.
Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio
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