Creating Competitive Advantage with Risk Management: The 5 Pillars


By Rob Garfield, Head of Product Marketing, FINCAD

The role of enterprise risk management systems in today’s leading investment firms stretches far beyond compliance. A growing number of asset managers regard these new systems as pivotal to the investment process itself – key to generating higher returns, setting a bottom for potential losses, improving margins, and raising the confidence of clients, investors and shareholders. Technology — once a major obstacle blocking risk management from reaching its full potential — has broken through. Where older systems traded speed for accuracy, new systems use techniques such as algorithmic differentiation and distributed computing to shatter speed barriers. Risk analytics no longer simply monitor performance but drive it, through intraday metrics that cover everything from vanilla instruments to exotics.

Leading investors use these systems to analyze the full spectrum of investments — intraday and on-demand. And when risk analytics are incorporated into regular trade-decision workflows, the rewards include better trading decisions and greater predictive confidence.

This article outlines the “Five Pillars” that define the core of today’s top risk systems. Though our analysis is rooted in what’s available now, “future-proof” architecture is key: the best systems are highly adaptive to change. Risk analytics continue to excel at compliance and down-side protection. The difference now is that leading investors have moved them close to the core of the investment process itself.

1. Fast
Make better trading decisions with timely risk information

Speed was once a roadblock to intraday risk analysis, but the latest technology has broken through, delivering fast and accurate calculations across models and analytics. Techniques such as algorithmic differentiation have been combined with sophisticated distributed computing methods, so processing power now scales to each portfolio’s size and complexity. Real-time and intra-day risk analysis are not only practical but, for an increasing number of firms, necessary. Stress tests and scenario analyses can be performed intraday and on-demand. The result of all this: better decisions from portfolio managers, traders, and analysts.

2. Accurate
Optimize Capital Deployment

Accurate metrics and hedging insights are crucial; today’s systems meet this challenge with industry-standard models that deliver consistent pricing, valuation, and data, including Greeks, sensitivities, hedge factors, and CVA. Precise analysis exposes over-collateralized investments, freeing capital for more productive use. And by tracking shifts in the zero rate curve rather than swap rates, risk re-projection more accurately monitors changing exposures in, for example, portfolios of bonds and / or interest rate swaps.

3. Flexible
Profit from new investment opportunities
An investment firm’s trading strategy can be an important competitive differentiator, drawing on its own analyses and assumptions. The “one size fits all” approach used by older risk systems lacks the flexibility needed to accommodate the vast range of potential approaches, and the rapid adjustments demanded by today’s dynamic markets. In older systems, adding new instruments requires new code, which can tie up analytical and development resources for weeks or even months. Today’s innovative systems use modular building blocks to accelerate the creation and valuation of nearly every kind of investment, including vanilla, exotic hybrids, and structured products. Analysts can access centralized libraries, where existing models can be adapted to accommodate new instruments in a fraction of the time. And robust APIs allow developers to make the best use of powerful analytics engines and data management services. Firms can now profit from opportunities that were once out of reach. Most risk analytics involves curve-building – OIS, cross-currency, and so on. The best new systems allow analysts to build custom curves that more accurately reflect their own views of the markets. Also, today’s systems are built to integrate with third-party trading and market data, security master systems, and internal workflows and applications, while core analytics include historical and Monte Carlo VaR, what-if’s, stress testing, scenario analysis, and a host of others.

4. Transparent
Provide greater transparency to investors and regulators

In today’s best risk systems, models are documented in detail, with citations that reach deep into original sources. Model validation is faster and simpler than ever before. And today’s leading systems ensure that all data — trades, prices, intermediate calculations, and results — are accessible for study and deconstruction, and fully auditable for validation and reconciliation. Analysts, portfolio managers, and traders are confident that the models they use are backed by documented research and testing – and consistent with their firm’s current investment. policies. Such transparent, well-documented models are considerably easier to defend with regulators, investors, and shareholders.

5. Holistic
Aggregated view of risk across the enterprise

Today’s market environment drives investment firms to demand consolidated insight into their holdings. By normalizing models and assumptions, the leading risk systems create arbitrage-free, holistic views of risk across the enterprise. Consistency and faster time-to-market inspire confidence in analysts, portfolio managers, and traders. Each comes to trust the advantages of working collaboratively, using consistent data, assumptions, and models.

Before the advent of true enterprise risk platforms, aggregating risk metrics was a painful and costly process, error-prone and time-consuming. Now that regulations such as MIFID III and BCBS 239 require such aggregation, firms that haven’t deployed holistic systems find themselves behind the curve. Individual business units may still be using custom models inconsistent with the firm’s policies. Also, analysts assigned to risk aggregation are not available to analyze portfolios under pressure, or new investment opportunities. By normalizing models and data, and bridging old silos, the best of today’s enterprise risk systems greatly simplify the aggregation process.

Truly, new risk platforms have “democratized” sophisticated Tier-1 analytics, eliminating artificial advantages, cutting costs, and reducing development time. These powerful platforms are now available to all market participants, not just those with unlimited resources. Speed, accuracy, transparency, flexibility, and a holistic approach have raised risk management to a new position as a direct source of competitive advantage. Firms that focus on these five pillars will deliver superior returns to those that do not, and will ensure their strategies keep pace with their opportunities.

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