If the financial crisis has brought home one lesson, it is that
apparently healthy markets can collapse in no time.
The flash crash on May 6 may not have been a real crash, but it
caused real losses, and reinforced that message, just as
investors began to feel that the worst might, perhaps, be
With this lesson in mind, it seems strange that some
derivatives traders are still relying on risk management
systems that are updated only daily – something many
believe is way out of date in a volatile market increasingly
driven by high frequency trading.
Or, as Nils-Robert Persson, chairman of software firm Cinnober,
puts it: "Clearing systems and risk management software
haven’t sold terribly well in the last 10
That is changing. Technology providers agree that there is a
new approach to risk management throughout the industry, in
which real time is becoming a reality. More firms than ever
acknowledge that they need to monitor their risk exposures as
fast as they create them.
A new opportunity
One of the first companies into this breach was
Sweden’s Cinnober Financial Technology.
Originally, it built trading systems for exchanges. When
several clients asked for customised clearing solutions,
Cinnober realised it had almost all the components for a
The resulting product, Tradexpress Real Time Clearing, was
released in April 2009. A year later, it won its first customer
for the system, and four more have ordered "very large"
Cinnober believes it has the "most modern clearing system
globally", and that the market for these solutions is much
larger than it had anticipated. "The largest investment banks
have a huge interest in clearing technology," Persson says.
"They even move faster than clearing houses."
Interestingly, when asked who gave the impetus for the new
solutions, Persson replies: "High frequency traders were among
those that approached us, as they wanted to calculate their
risk in real time. While they were running their own processes,
they were looking for a second party to provide real time risk
management so they could check if their systems were running
correctly or spinning out of control."
The OTC story
Tech providers to the OTC markets have a similar story to tell.
Being so vast, the OTC business has become a victim of its own
success, which tore open the gap between front and back
"The OTC markets had been growing so fast that banks are only
now figuring out how to deal with that growth. Frankly, the
infrastructure wasn’t capable of scaling up to the
extent that the market has grown," says Rohan Douglas, CEO of
New Jersey-based Quantifi, which provides valuation models,
risk management software and consulting services for the credit
and fixed income markets.
"Banks used to accumulate huge backlogs of unsettled trades as
their infrastructure couldn’t cope with the speed
of the trades," Douglas recalls. "This was already beginning to
change pre-crisis, but regulatory pressure has certainly
helped. Another factor that has helped is the increased
standardisation of OTC trades. While a lot of OTC trades still
have unique characteristics and there are still gaps in that
area, standardisation has made progress and has gone a long way
to make processing and settling easier and faster."
From Quantifi’s perspective, most activity is now
happening in the interbank market, where big firms want to
electronically trade, clear and settle credit and interest rate
products as fast as possible. The next step will be connecting
these processes to the clearing houses. In a third step, there
will be a roll-out to investors, who will get the same trade
data and execution.
"This is where we see our biggest future market –
connecting the systems on all three levels," Douglas
Rather than risk management being something people were happy
to leave to the end of the day or the next morning, there is
now growing demand for risk analysis even before trades are
"The speed gap between the front and back office is most
definitely closing," says
Ed Gouldstone, hedge fund product manager at Linedata
. "Back in the day, the back office didn’t even
look at a day’s trades until the next morning, but
that process has now sped up and the data can be audited at any
At the same time, the view on the portfolio is becoming more
holistic, as institutions want to immediately gauge the total
risk of positions as the market and their portfolio changes
during the day.
"The goal is real time updates as the market changes and new
trades are done. In practice, more complex products which take
longer to value and limited market data for less liquid
products restrict what can be done," says Douglas.
Whether a firm needs real time risk management also depends on
its strategy. Active hedgers need fast updates, while
buy-and-hold institutions can simply ride out volatility and
don’t want to be informed of every tick
One of the most formidable challenges systems providers face is
the sheer quantity of data and number of data
Linedata has been
offering a real time portfolio management tool to its clients
for five or six years, driven by the need to bring the various
spreadsheets and data feeds into one portal
. Of Linedata’s 700 clients, around 300 are hedge
"Hedge funds and investment firms are high volume consumers of
data. With thousands of ticks streaming into their systems, the
volume of data they need puts a big strain on their IT
infrastructure, so stability is key and the question how best
to make use of the infrastructure and the incoming data,"
explains Gouldstone. "A
nother key focus is to know the exposure across the portfolio,
so they need solutions that update positions tick-for-tick.
With a portfolio of 40,000 positions, that can be quite a
What users want
Asked what clients need today, software providers highlight
several areas they are working on.
Valuations and the ability to customise are high on the agenda,
as well as being able to process huge quantities of
information. "A primary need is to get good data and more
frequent data, which is especially important as the OTC market
isn’t as liquid as the exchange-based market,"
But there are also new demands that have moved centre stage, as
firms become more keenly aware of certain risks.
One of these is counterparty risk. While this has always been a
concern for banks and brokers, now even investors are on the
watch for banks or other institutions that might
"With the markets as volatile as they currently are, customers
also want to know where their [counterparty] risk is –
not just on a daily basis, but on an intraday basis," Douglas
Another peril that has made global headlines is rogue
"Our clients currently request to be able to manage the [rogue]
risk at different levels: traders, group of traders, trading
enior vice-president for post-trade services at SunGard Global
Trading in Paris. "
Previously, orders were checked individually, but nothing
caught traders trading through different accounts or through
brokers in a give-up process. [Our system] would catch out
rogue traders who trade through several accounts to evade
entered the real time risk management market around five years
ago with Stream Instant Control.
But it doesn’t have to be human mischief creating
trouble. The sheer complexity and speed of trading create new
demands on IT systems.
We’ve noticed increased client requests to monitor
give-up acceptance," says Rousseaux. "They need to keep track
of positions acquired via several brokers and our system Stream
Instant Control automatically consolidates all orders,
regardless who executed them. This prevents traders taking too
big positions and moving out of their limits. A strong demand
also comes from firms that grant clearing to their DMA
customers, as they need to monitor their total risk acquired
Speaking the same language
Other challenges arise from inconsistencies within the same
firm. Historically, many traders used their own pricing models
which did not necessarily match the way the firm marked or
processed trades in the middle office.
Several tech firms have tackled this issue, bringing front and
middle office on to the same page. Quantifi, for example, has
integrated models that Douglas says "are accurate enough for
the front office traders and for risk management and trade
processing". This is intended to give consistency in valuation
through the whole trade process.
Calypso Technology’s front-to-back office system
is based on using one system for all three levels of the
ensuring that they can all view a trade
In many cases, the front office have their own pricing modules
and pricing environments to price trades. The middle office
might not have the same data and pricing. Since we provide one
system, everybody in the bank uses the same modules and there
is no reconciliation necessary," explains Naveed Ahmad,
business analyst at Calypso in London.
Other clients want functional integration and simplification.
In the last six months," says Rousseaux, "our customers are
specifically asking to combine different functionalities that
we used to offer via different software solutions.
The need is to bring together all the data
streams and bring them on one platform."
Increasingly, he says, clients need to combine different
figures and models when calculating value at risk. So they need
to see what their risk is across portfolios and asset classes,
taking into account both standard models like Span or Tims and
their own risk ratios and standards.
Speed, simplicity and a narrower focus on the essentials are
demands that Ahmad highlights: "I think clients increasingly
realise that they don’t need all-singing,
all-dancing systems that brew their coffees in the morning.
They are willing to give up shiny extra functionalities they
don’t actually need in favour of faster, more
responsive systems offering functions that they really
Regulators force the pace
The markets of the past may not have been riderless, but many
jockeys were more concerned with keeping up with the field than
exercising a great deal of informed control over their
Now, everyone feels the regulators’ push towards
transparency. As Persson puts it: "Now the regulator demands
that market participants have to know exactly where their risk
is at any given time. And clearly, not knowing that can no
longer be acceptable."
The authorities’ demands go even deeper than that,
Gouldstone (pictured) points out, such as being able to tell by
how much positions were over the limit and for how long. Such
data retrieval allows regulators to engage in forensic analysis
at levels previously undreamed of.
Much greater detail is not the only challenge. As
SunGard’s Rousseaux explains: "
Audits to the regulators will no longer be at the end of the
trading day, but will have to be done on an ad-hoc basis when
the regulator requests them."
In the US, the Securities and Exchange Commission has even
decreed that brokers with direct market access must calculate
their risk in real time. "This is a new demand caused by a new
requirement that wasn’t around two years ago,"
The real time adjustment is not just affecting trading firms,
but exchanges and clearing houses too. "Markets that
don’t have modern infrastructure need to know that
all positions in the market are covered with collateral, thus
ultimately ensuring market stability," Persson says.
This impetus will gain force as regulators try to push more OTC
trades into clearing houses. With higher volume, says Persson,
"real time risk management for the clearing houses becomes
crucial, or you just gather systemic risk there and do nothing
to manage it."
More demand might be created by further regulatory
requirements, which are due to be passed in the EU and will be
fleshed out in the US over the next two years.
Changes could be dramatic – or even traumatic
– on the OTC side, even though the exact shape and
implementation of recent and future regulation is still very
much in the air. However, tech providers agree that the big
rend is clear. There is a strong push towards transparency,
more electronic execution, clearing of OTC trades and more
transparent access to market data.
"Some changes are less driven by the banks themselves but more
forced upon them by regulation. New regulation aims to bring
more transparency and competition which is not necessarily
something that the banks wholeheartedly welcome, especially on
the execution level and with regards to market data," says
Tech is no barrier to clearing
One of the arguments the industry has used in consultations
with regulators is the huge demands some of the legal
provisions could place on firms’ software and
To resist more clearing, some industry figures have claimed
that it’s "technically impossible".
Tech providers beg to differ. "To those we say, it is
impossible when you’re using technology of the
’70s and ’80s, but there was a lot of
progress, and those solutions are no longer a problem. We, for
one, have the technology," Persson insists.
The real source of resistance is elsewhere, he believes: "Some
of these changes might cut into firms’ profits.
There are strata of the industry, especially in middle
management, where technological change is resisted to protect
bonuses. To these, more efficient markets and processes can
Of course, costs are always a hot issue. Efficient systems
don’t come cheap.
"Expenditure seems to be the main obstacle for investors such
as hedge funds that have just started out and maybe have
20m under management," Gouldstone explains. "They have to pay
for their infrastructure from their management fees at the
start and some struggle to afford it. Conversely, the
established players in the market have more financial freedom
and are keen to get updates."
tech firms say that once clients have been won over, they come
to fully stand behind the new procedures and
"This is a conversation I’m having more and more
often with our customers," Gouldstone says. "They tell me that
they’ve really started to appreciate the value of
having real time data. Increasingly, they can justify the
necessary spending to have that real time view."
Only the beginning
Tighter regulation, more complex trading and new awareness of
risks have been some of the effects of the financial crisis on
the real time risk management market, both in terms of client
demands and what tech providers offer.
Risk models and the way processor capacity is used are more
efficient than ever. Calculations that used to take hours and
were conducted many hours after the fact can now be done in
seconds and on an ad-hoc basis.
In short, the changes have been dramatic, which is likely to
continue as risk management overall has evolved from 'nice to
have’ to a business-critical core
"Senior management would like to see the risk positions in real
time across a wide set of products and geographies to allow for
quick and accurate decision making," claims Ahmad.
Closing the speed gap between trading systems and clearing
systems fully might not necessarily be essential – or
could be superseded by the need for transparency through all
offices, from front to back.
It might not move towards the back office keeping tabs on the
front office any time soon. For these people, the priority is
to have access to the same kind of data and look at the same
exposure as the front office for auditing and transparency
But some market participants feel that the present drive
towards faster real time management and pre-trade risk
management is only the beginning. Or that the two horses will
eventually not chase each other, but run in tandem.
"There is no reason for a trade to take three days to be
settled," believes Persson. "I feel the development will be
towards immediate settlement, collateralisation and payment.
But this is likely not a point we will reach in one year, but