Dodd-Frank Raises Stakes for Counterparty Risk

Terry Flanagan

Dodd-Frank’s requirements for central clearing of OTC derivatives as well as for credit risk management have challenged fund managers struggling to achieve compliance.

Although central clearing of OTC derivatives will mitigate some counterparty risk, firms are still exposed to other types of default risk.

This is primarily due to the current technology landscape, where disparate systems across the front-to-back office make it an uphill battle to calculate exposure, automate and optimize collateral allocations, and automate position valuation and generation of variation margin.

The greatest challenge for risk management is the ability to view exposure across the firm’s entire book of business, said David Kubersky, managing director of SimCorp North America, a provider of investment management software and services.

In a recent SimCorp poll, 30% of buy-side firms stated that it would take them days or weeks to calculate their exposure across all holdings.

“What this means is that in a distressed situation such as in the collapse of Lehman Brothers, 30% of buy-side firms would not have a timely view into their exposure to the distressed party, leaving them unable to react quickly,” said Kubersky.

The Dodd-Frank Act, a major reform of U.S. financial regulation, is an opportunity for firms to comprehensively address exposures across the enterprise.

Forward-looking firms tend to view compliance not as a hurdle, but as an opportunity to reshape their businesses through improved record-keeping and workflows.

“Those companies that choose the path of minimal compliance, of doing the least possible, are missing out on an incredible opportunity to revamp their business,” Kubersky said.

Faced with increasing demands for greater transparency and mounting regulatory requirements, firms are in need of better performance and data processing capacity.

SimCorp Dimension, for example, its flagship product, has launched a number of enhancements across the front, middle and back office, including credit default risk calculation and collateral optimization.

“The impetus for the enhancement has to do with the challenges faced by investment managers across the globe to accurately estimate the outcome if a company defaults,” said Kubersky. “There are many exposures to take into account in a multi-asset class portfolio.”

The credit default risk module facilitates calculation of profit or loss in case of counterparty default across all holdings. Clients can combine all default exposures in one calculation without having to interface or reconcile with other systems.

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