The worldwide economic crisis may not be over and regulations may not be finalized on how to prevent a recurrence.
But financial firms can bet their bottom dollar on two certainties: The first: Regulators will want to know just what has been traded, when and for how much. The second: they will also want to know firms are calculating – and mitigating their market, counterparty, operational and credit risk.
Both translate into lots of spending on new business processes, systems and infrastructure. The following represent a summary of three of the potential new regulatory requirements likely to be addressed at the Securities Industry and Financial Market Association’s operations show in Palm Desert, California this week and how they could impact their tech budgets.
Centralized Clearing of Over-the-Counter Derivatives: Firms which need to clear their “standardized” OTC derivative contracts through a central clearinghouse must price those contracts daily instead of either only at the end of each calendar quarter, upon a client’s request or when there were favorable market conditions. “Marking derivatives daily requires a huge number of accurate inputs such as interest rate curves, currency exchange rates, closing prices of underlying hedging instruments such as Eurodollars or commodities, real-estate statistics or even weather forecasts,” says Aleksey Maslov, senior associate for Lab49, a New York and London based consultancy in technology strategy and implementation for financial services firms. Daily pricing of derivatives will also require daily risk calculations which also means more data and computation power because it involves the creation and execution of multiple scenarios. Firms must vary the inputs and recomputed prices to discover how derivative contract values may change under varied market conditions. Impact:Firms will need to buy real-time online analytical processing (OLAP) tools to allow them to slice and dice the risk metrics.They will also need distributed grid computing software and large scale data warehouses to crunch and store large quantities of data, says Maslov.
Greater Disclosure of Underlying Data: The Securities and Exchange Commission has proposed that Wall Street firms that package and sell asset-backed securities be required to hold at least five percent of the packaged loans on their own books as a condition of the SEC allowing them to sell the asset-backed securities to investors. Firms will also have to disclose information on every underlying loan in a package. For example: What type of mortgage loan was involved. Provisions in the House and Senate versions of financial reform legislation also would require “securitizers” to keep some of the risk themselves. Impact: Firms must ensure the accuracy of the data on the asset-backed securities and augment their data with data from third-parties. That means they will have to find a way of aggregating internal and external data. They will also need larger data warehouses to store all of the information as well as custom-built software to clean, reconcile and manage the data.
Systemic Risk Regulator: Someone will have to figure out just which firm is most likely to fail and what that failure will mean to the entire financial market. A proposed National Institute of Finance would collect data from the back offices of major firms on a daily basis and perform a what if analysis for the systemic risk regulator. Impact: Firms will have to buy or build data cleansing and aggregation tools to keep track of their position, transaction, reference and counterparty data. They will also need to decide who will be responsible for ensuring what data is kept where and in what format to prepare the reports for the regulator. The largest financial firms will likely create a new special regulatory reporting unit.
New Reporting Requirements: Firms may have to generate additional market and counterparty risk analysis and stress testing reports for a systemic risk regulator, the Securities and Exchange Commission, the Fed Reserve or any other regulator. Impact: Those risk analysis and stress testing reports will require additional modeling and risk calculations further increasing demand for computing power and integration with large distributed data repositories hosting the data needed for the calculations and storing the results. The market data, industry statistics, indexes and pricing of hedging instruments will need to flow quickly from trading desks to quant and reserve divisions and the back to reduce the time it takes for the trade to be incorporated into valuation, risk analytics, scenario modeling, value at risk and capital reserve calculations. Impact: Firms will need to invest in distributed grid computing software and message buses as well as dashboard visualization software. Distributed grid computing software will allow firms to crunch data faster while message buses speed up the transfer of data between applications. Dashboard visualization software allows firms to more quickly determine the level of risk for each business and product line and the type of risk involved.
Which is the four could end up being the most costly regulatory requirement? While financial firms might be griping about the data requirements of a systemic risk regulator, clearing standardized OTC derivative contracts will be the most cumbersome and costly to implement, according to Daniel Chait, managing director of Lab49.
Besides the staggering amount of data that might be required to value the OTC derivative contracts, firms will also need to manage collateral, connect to multiple clearinghouses and potential clearing brokers and potentially change the terms of business contracts if they wish to create standardized derivative contracts. They must also figure out just which contracts can be cleared through a clearinghouse and which ones might have to be bilaterally cleared. That means every department of a firm is affected: from the trading and sales desks all the way to the middle and back office.
“Firms will need to reengineer their existing systems, create new platforms from scratch and buy new systems to handle the entire lifecycle of an OTC derivative – from their issuance to trading, clearance and settlement and risk management,” says Chait.
This article can also be found at SecuritiesIndustry.com.
Register or login for access to this item and much more
All Information Management content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access