Wall Street Firms Using CEP to Measure and Manage Risk

New complex event processing applications promise to help firms get a better handle on their risk exposure, but can CEP erase Wall Street's risk management woes?

One of the many effects of the credit crisis is that Wall Street firms have found a new focus for their complex event processing projects. Although they're not abandoning CEP-based algorithmic trading, new CEP initiatives are focused on measuring and managing risk.

With its ability to watch and apply business rules to massive streams of fast-moving data -- such as trade quotes, trade orders and news -- CEP can help traders and risk managers gain a clearer view of counterparty risks, judge exposures to certain firms and sectors, and perform backtesting in close to real time, according to experts. And once links to data sources have been built and basic functions described, building new risk applications on top of a CEP platform can be much faster than creating a new application from scratch.

But while CEP can provide visibility into risk problems and perhaps help prevent certain mistakes, observers caution that it's not a replacement for good judgment, common sense and sound risk management practices. Further, it's unlikely that CEP-based risk management systems could have prevented the collapse of the subprime lending market, the resulting credit crisis, or its spread to Wall Street and the global economy.

"The last couple of months have shown that while everyone agrees that risk management is wonderful and everyone should have lots of it, now that's really, really, really true," says Simon Garland, chief strategist at Kx Systems, a provider of high-speed data management solutions. "With financial data -- especially market data -- risk management can only be possible with systems that can handle enormous amounts of data coming in." And that is precisely what complex event processing is designed to do.

Many risk management systems today, Garland continues, still report risk measures at given intervals, such as at the end of the day, rather than keeping up with real-time trading systems. "That's not going to cut it any more," he says.

"The checks being written to us are mostly for risk-related solutions," concurs Terry Cunningham, CEO of CEP solutions vendor Coral8. "If you work at a big Wall Street firm and say to your boss, 'I want to buy cool new software,' you don't get past the first three or four words. You have to tell a pretty compelling story to get past the first sentence. If you talk about risk, you'll at least get them to listen for a little longer and pay attention to the possibilities."

The Case for CEP-Based Risk Management

As Lehman Brothers was tottering on the brink of bankruptcy in mid-September, some firms couldn't quantify their exposure to the bulge-bracket firm. They simply didn't have all those positions aggregated in one place. (Even if they did know their total exposure, Lehman's second-quarter numbers weren't that dire; quantitatively, an investment in Lehman didn't appear to be that risky.)

But CEP vendors say their software can give risk managers a better view of such counterparty risk. "No software can replace [good] judgment," says Jeff Wooten, VP of Aleri. "What [CEP] software can do is give you better information with which to make those judgments and a better understanding of where you stand." CEP software provides a way for firms to aggregate information from different parts of the organization and layer analysis on top of that, he explains.

"Our software can't help you predict what's going to happen with your counterparty; it can't help you predict that Lehman will declare bankruptcy," Wooten adds. "But it can help you know what your exposure to Lehman is."

Progress Apama's customers are using the vendor's CEP technology for pre-trade risk checks, according to John Bates, general manager for Progress Software's Apama division. "Before a trade is placed, real-time rules detect 'fat-finger' errors, check for decimal points in the wrong places, apply real-time compliance rules, make sure the firm is not over 6 percent of an actively traded market," he relates.

"Risk management used to mean that at the end of the day you'd run a value-at-risk calculation to find out what your exposure was," Bates continues. "Now people want a to-the-second view of risk. You can work out for each trader what the potential exposure and profit and loss is, and then you can roll it up to the whole desk and even up to the level of the whole institution."

According to Bates, hedge funds have been building CEP-based risk management into their algorithmic trading systems, and a number of Progress Apama's big sell-side customers are performing real-time hedging for foreign exchange using CEP.

Tibco customers are considering using its CEP software for "predictive straight-through processing," according to Spencer Greene, CTO of financial services for the vendor. "It's not so much predicting which trades are going to break, but it's looking at historical data [on past trade breaks] in real time and grabbing more information before a trade hits the breakage point," he says.

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