What’s causing the shift towards systemic and counterparty risks?

The sudden jolt to the system caused by the pandemic two years ago exposed the imbalance between sudden demand shifts and supply chain disruptions — crippling pretty much every sector.

Supermarkets rationed prime necessity goods, automakers were halted by a shortage of computer chips, and financial markets struggled to cope with unprecedented volumes.

Recent global events have further disrupted the market, bringing about systemic upheaval, which in turn put a lot of pressure on legacy systems that aren’t designed to deal with such unprecedented volumes. More than two years later, it is now expected that intraday volatility will persist in future, with no sight as to when prices will normalise.

While no-one could have foreseen these disruptions, risk managers are rightly considering what protocols should be in place to be better prepared going forward.

In recent months, there has been greater, concentrated focus on counterparty and systemic risks.

With such high levels of volatility, how can market participants accurately calculate margins on derivatives at scale and on time? Why are they unable to better predict risks? 

Rethinking risk management

The sudden directional repricing of specific assets is forcing both sell-side and buy-side organisations— more than ever—to rethink the way they manage risk. In particular, recent market uncertainty has shifted the focus away from performance and scalability (on the sell-side) and asset allocation (on the buy-side) towards systemic and counterparty risks.

Processes that have been in place for years are suddenly outdated, including the technologies historically employed to assess risk and proactively manage it with the use of predictive tools.

While firms have generally been able to perform an intraday assessment of portfolio evaluations, the recent violent price spikes have revealed their inability to perform a true real-time assessment of risk and liquidity requirements, taking into account margins imposed by clearing houses to its members, or indirectly to end clients via third-party brokers.

Several market participants have been consistently on the back foot due to the speed and extent of price movements across different classes, unable to perform effective forecasting as turbulent market events kept unfolding.

Risk managers can no longer afford to carry out manual tasks to perform their function, compensating for gaps in their current solutions.

Just as airplane pilots have cockpits providing real-time telemetry of all key aircraft and flight indicators, risk managers need dashboards providing a real-time view of all key risk and liquidity metrics, supported by automated alerting mechanisms.

What has been a reality for decades in airlines and other industries, has been historically unattainable in the financial derivatives industry. Approximation and latency however are no longer acceptable.

Employing new technology to face the future

Ten years ago, the adoption of technology providing an accurate, real-time view of risk for cleared derivatives would have been too complex, too expensive or both.

This was largely due to the fragmentation of systems across execution and post-trade, absence of modern solutions providing real-time risk metrics and replication of exchange margin methodologies, and lack of interfaces enabling aggregation of data from different sources.

New technology solutions providing what traders require in the current environment are actually available: during recent years risk platforms have been re-engineered and complemented with modules allowing to support real-time calculation of all key risk metrics, at scale.

Standard integration interfaces with execution, clearing, trade processing systems and real-time market data sources allow to source and aggregate all inputs required to provide a complete and accurate view of risk across the business.

Modern interfaces allow end-users to easily configure dashboards to meet their specific needs, displaying metrics across different dimensions, by client, by individual portfolios, by exchange or industry sector (energy, metals, soft commodities etc), drilling down at individual trade and position level.

A more intuitive and flexible user interaction allows in the same interface to easily simulate the impact of new positions or price shifts on “live” portfolios, and related impact on margin requirements and net liquidity.

It is no longer necessary to employ different solutions to meet the needs of different consumers of risk-related data. Risk managers can employ automated solutions that make their workload manageable. Also, during periods of intense market volatility, traders can take better informed investment decisions.

On the back of accurate analytics, clearing firms can have a real-time view of all client positions and liquidity, and their own exposure with Clearing Houses and third-party brokers within the same application.

Speed of change

We have the technology needed and, most importantly, all the data required to effectively manage risk. However, broad adoption has been hindered by insufficient investment and its lower relative priority compared to other critical functions within financial firms.

Anecdotal evidence suggests that historically, risk managers have not taken an active role in the selection of tools to support their function. Being unable to obtain sufficient budget and actively drive investment — often inheriting systems deployed by their former colleagues several years before, risk managers find themselves in a tricky situation.

Recent global events represent a catalyst for change and will accelerate adoption of new technology across the industry. It is no coincidence that risk management is now very high on the agenda of financial institutions across buy side and sell side.

Putting risk management front and centre will be the driving force needed to evolve existing business processes and minimise or even pre-empt the impact the next disruptive market event.

Francesco Margini is head of Product Management, ION Markets – Cleared Derivatives