In today's volatile markets financial institutions are under
intense pressure to analyze and control their risks. Global
economic uncertainty, plus ever more extensive and complex
regulation, requires institutions to be able to measure and manage
market, credit and liquidity risks in a consolidated manner across
all instruments, portfolios, business lines and geographies.
At the same time, they must continue to generate revenue in
intensely competitive markets. To succeed in such an environment
requires a technology infrastructure that is integrated, efficient
and cost effective.
In recent years, many institutions have benefited from
straight-through processing (STP) between front- and back-office
systems. Trading and risk management have lagged behind because
there is often duplication and inconsistency in pricing that must
be reconciled before aggregation and analysis can begin.
STP for trading and risk can be achieved by creating a single
platform with common pricing and analytics. This consistent
platform will provide a bridge between the front office and risk
management, enhancing communication and allowing experts to focus
on their core tasks. The result will be improved efficiency,
reduced costs and better decision-making.
The Problem
In a traditional infrastructure, front-office trading is
optimized for making the best deals and hedging positions, for
which it needs advanced pricing tools and sensitivity analysis.
Meanwhile, risk management has the responsibility for oversight of
trading activities and calculating enterprise-wide exposures, so it
too prices the deals before it aggregates positions, runs
value-at-risk (VaR) calculations and monitors limits.
Herein lies the crux of the problem.
Trading and risk can use different pricing methodologies. In
these instances, results must be reconciled and any discrepancies
resolved before risk management can proceed with its aggregation
and analysis.
This delay not only hampers the timely calculation of risk
measures, but also holds back the development of new products and
activities, as each new instrument and pricing model must be
developed twice - in the trading system and in the risk system.
Many of today's trading systems offer at least some degree of
risk management functionality. However, this does not necessarily
solve the problem. They remain trading systems at their core. The
risk functionality is focused on the trades captured in that system
and is therefore not sufficient for a risk manager.
To support a complete risk management process, the institution
may be forced to supplement the trading system functionality with
consolidation engines, limit management applications and a host of
intermediate tools that glue things together, often including
macros, spreadsheets or other applications, which can be difficult
to manage and maintain, and increase operational risk. Trading
system risk functionality is naturally tailored to the specific
system and is not well suited to aggregating and managing data from
several sources.
The conventional alternative is to install a dedicated
enterprise risk management system that is designed to aggregate
trading data and calculate enterprise risk measures.
While these systems can offer sophisticated enterprise risk
capabilities, they are at a step removed from the trading
environment, employing their own models for pricing and risk
calculations that must then be reconciled with the front office
data and models. This makes them costly to install and maintain,
and hampers the fluidity of the interaction between traders and
risk managers.
An Integrated Solution
Taking a step back, we can see that there is another way to
tackle the problem.
Modern front-office trading systems come with sophisticated
pricing libraries and valuation methodologies that of necessity are
accurate and fast. If it is the duplication of this functionality
in the risk system that is the cause of the inconsistencies and
inefficiencies that plague many risk management efforts, why not
simply use the front-office pricing and eliminate the need for
reconciliation?
By closely coupling the trading and risk systems to share
pricing models, the institution gets the best of both worlds --
fast, accurate pricing plus a tightly integrated system that is
efficient, reliable and consistent.
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