Taking the Risk Out of Risk Management

Terry Flanagan

Hedge funds and other financial organizations are being challenged to improve the efficiency and accuracy of their risk management functions, largely in response to new regulations that mandate reporting of derivatives transactions as well greater accountability and transparency.

“Dodd-Frank’s requirements for central clearing of OTC derivatives as well as for credit risk management has challenged fund managers struggling to achieve compliance,” David Kubersky, managing director of investment management software and service provider SimCorp North America, told Markets Media.

“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, automate position valuation and generation of variation margin.

“The greatest challenge for risk management is the ability to be view exposure across the firm’s entire book of business.”

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,” Kubersky said.

The investment world has changed dramatically in recent years with complex investment strategies that allocate to diverse asset classes, including alternative funds, private equity, long-only funds, commodities and more.

“Even diversified portfolios are often more correlated, requiring more frequent rebalancing and course correction,” said Brendan Dolan, president of PerTrac. “In this environment, asset managers require institutional-quality software to access and manage multiple databases of traditional and alternative investments, and analyze along a broad array of risk/reward criteria.”

PerTrac provides fund managers with the tools they need to highlight how their funds perform under various market conditions and in comparison to their peers, said Dolan.

Core risk management challenges include the consolidation of position-keeping in order to get a real-time view into the firm’s exposure, and mitigating the risk associated with poor data quality that arises from the manual reconciliation of data between disparate systems.

Kubersky of SimCorp said: “Investment decisions based on poor data quality could lead to financial loss as well as reputation harm.”

SimCorp Dimension allows fund managers to consolidate positions across all holdings in a central repository which in turn provides a timely 360 degree view of both investment performance as well as exposure, said Kubersky.

Additionally, SimCorp’s straight-through processing automates workflows across the front-to-back office, mitigating the risks associated with manual processing. Kubersky added.

“We believe there should be shared responsibility for risk management across the firm,” said Kubersky. “Risk management is not just about sophisticated risk models but it is very much about getting the basics that matter right.”

Risk management functions may be centralized under a chief risk officer, or dispersed throughout firms.

“Across our client base, we have found that there are a variety of models that investors use including both centralized and decentralized risk organizations,” said PerTrac’s Dolan. “In most clients, regardless of structure, risk is regularly reported to their investment committees.”

The risk management department typically covers market, credit and other derived risk areas such as liquidity risk. Typically there is a chief risk (and compliance) manager for this function, which reports to executive management. Depending on the size of the organization there can also be an operational risk manager and an internal/external regulatory compliance manager.

“These functions are closely linked together and may in some financial institutions all be in one department,” Kubersky said. “Very large financial institutions will have market and credit risk departments for different lines of business.”

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