Risk management has been growing in importance over the last decade. Awareness surged after the collapse of Barings Bank in 1995 when one derivatives trader brought down the 233 year-old institution as a result of the absence of a checks and balances system. The Orange Country bankruptcy later that year only heightened awareness that institutions needed more stringent risk management techniques. Since these debacles most institutions have implemented risk management technology. Now they are asking for souped up versions of what exists on the market.
Looking For Enhanced Credit Risk
Recently credit risk management has come to the forefront stemming from last year's Asian market crisis, the devaluation of the Russian ruble and the liquidation of Long Term Capital Management. As a result, institutions are looking for enhanced tools to assess credit risk as well as systems to provide an integrated risk profile. Integrated risk management takes into account credit, market and liquidity risk. These incidents have also highlighted the importance of enterprise-wide risk management-which provides the ability to assess an entire institution's risk profile from its trading book to its banking book. Professionals throughout an organization want access to enterprise-wide risk reports-and they want them in a simple and understandable format-whether they are a trader, a back-office staffer or a CFO. As a result, vendors are stepping up to the plate-enhancing technology to satisfy their clients.
An official from Algorithmics says credit risk has always been important but he is seeing a "clear move toward more and more sophisticated credit risk modules." He notes that his firm is planning to enhance its credit risk modules through a credit limits management system called RICOS, which it acquired last year. Algorithmics plans to work the RICOS technology into its main product RiskWatch. The enhanced credit risk functionality will be released as part of Algosuite Series 3.2.
Furthermore, Algorithmics' new product will be able to calculate credit VaR. The official adds that Algorithmics can measure credit risk and market risk jointly. "... There are several tools or methodologies in the market that calculate credit risk, assuming market risk is constant. This product allows people to calculate ... the interaction of the two risks." He provides the example of the industry's difficulty in modeling wrong way exposures. "This is where the exposure in a swap goes up and, at the same time, the credit risk of the company defaulting goes up," he explains. Traditional systems have a hard time dealing with this. "Integrating market and credit risk has made it straight forward for us to do that."
Alex Tsigutkin, president of Axiom Software Laboratories, a N.Y.-based enterprise-wide risk management vendor, is also enhancing the credit risk calculations of its product RiskMonitor. Although he would not reveal specifics on the methodology-for fear of giving information to his competition-he says, "it will take into account various default distributions and the aging of credit ratings." He adds that it will incorporate collateral management and various types of netting taking into account rare events to which credit risk is very susceptible. He notes the earthquake in Taiwan, which impacted chip makers, as an example. Tsigutkin says Axiom chose to enhance the credit risk area "because of the events that have taken place in the past couple of years."
Integrated Risk Management on the Way
Along with a plea for enhanced credit risk modules is a cry for integrated risk management solutions-encompassing credit, market and liquidity-as well as the ever-important enterprise-wide risk management solutions. Enterprise-wide risk management has been a buzz word for quite some time and many products offer it. Now users are looking for a way to lower integration costs and simplify the manner in which the enterprise system pulls data from institutions' existing databases and systems.
To support this need, many risk management vendors are implementing XML into their product offerings. Chuck Jones, product manager with BARRA, says that 70-80% of the cost of a system is the implementation. He notes that his firm is working on integrating XML into all of its systems, which include Aegis for equities, Cosmos for fixed income, and BARRA TotalRisk for enterprise wide risk management to facilitate integration and reduce cost.
Brian Robins, senior v.p. of marketing at SunGard's Infinity Group says his group's plan for the Year 2000 is also to "focus on integration." By using XML, Robins adds that SunGard plans to enable integration of its risk products, facilitate the installation process, and enable users to communicate with counterparties. "We've been developing interfaces for quite a while and we are standardizing using a common message format which we call Network Trade Model. All of our up-and-coming releases support this message format for the exchange of transactions." The format is XML-based and "allows for the exchange of transactions, transaction details and transaction lifecycle of events in an extensible format-which is Internet ready and firewall friendly," Robins adds.
Askari, too, a business unit of State Street, is placing its bets on XML. Its new product-RiskBook X which will be released by the end of this year-will be XML-based. RiskBook X provides a "model engine" application programming interface that allows clients to pick from the pricing modules available in the market place and incorporate them into the RiskBook system, says Eric Reichenberg, managing director. He notes that using XML-which will represent positions by describing them-will be used to communicate through the model engine. This way the underlying code of Askari's product does not have to be changed, he says. Indeed with the wider use of enterprise-wide risk management, these risk systems must be able to interface with many more systems throughout a financial institution, in addition to its counterparties. Many vendors agree that XML will make this transition smoother.