Firms Reassess Risk Management Strategies

Terry Flanagan

Companies are re-evaluating their framework for measuring and monitoring financial risk in light of current economic conditions and the fallout of failed financial risk policies.

“Without a solid grasp on areas of risk exposure, it is challenging for companies to design effective risk reduction strategies,” said Michael Bosacco, vice-president of treasury solutions at AvantGard, trading technology firm SunGard’s corporate liquidity business.

“Uncertainty surrounding risk exposure makes it difficult for corporate treasurers to make informed decisions and reduce potential losses, making identifying and measuring risk crucial to a company’s survival,” Bosacco said.

In a SunGard AvantGard survey of 222 treasury professionals in the second quarter of 2012, 86.9% said that they have an established framework in place for mitigating financial risk. Furthermore, 60.4% of respondents felt their organizations were above average at identifying financial risk exposure, identifying their companies as somewhat to very effective.

The SunGard AvantGard study identified seven types of risk: commodity, counterparty, credit, currency/FX, interest rate, liquidity and market risk. Respondents identified market risk as the most difficult to measure, followed by counterparty and commodity risk.

Interest rate risk was identified as the easiest to quantify.

Philippe Buhannic, CEO, TradingScreen

Philippe Buhannic, CEO, TradingScreen

“There is a set of new regulations emerging –Dodd-Frank in the United States, and other similar regulatory packages in Europe, Australia and elsewhere – which will present new challenges around over-the-counter asset classes migrating to exchange traded models,” said Philippe Buhannic, chief executive of TradingScreen, a provider of liquidity, trading and investment technology. “There is a good deal of complexity in the pricing and margining of these new asset types.”

In addition, there will be significant challenges around collateral management and coordination of payments and receipts. “From a technology point of view, these challenges can only be answered by the merger of the functionality of the order management system and execution management system,” said Buhannic.

The SunGard study identified market risk as the most difficult area of risk to quantify.

A possible contributing factor is that most respondents viewed their positions retrospectively rather than in real time. Sixty per cent stated that they viewed their positions retrospectively, while 34.7% of respondents monitored market positions in real time with 5.3% unable to monitor positions.

“The inability to monitor markets and portfolios in real time could inhibit the ability to measure the effects of market risk and potentially undermine the ability to identify future exposure,” said Bosacco.

When estimating the effect of major market events, 57.9% of respondents viewed the effect on their entire portfolio, while 14.7% focused on individual derivatives. Over a quarter of respondents – 27.4%– stated that they could not estimate the effect of major market events on their companies’ portfolios.

Counterparty risk was identified as the second most difficult measurement.

A significant majority of respondents (65.4%) utilized credit ratings as the main criteria to measure the viability of a potential business partner.

The next most utilized measurement was capital structure, with 12.1% of respondents using measurements like debt-to-equity ratio.

Credit default swaps spreads, which are a way of looking at the price of insurance against nonpayment, were used as a measurement by 10.4% of respondents.

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