On the heels of the global credit crisis, it's only natural that financial services firms would focus on beefing up the systems they use to manage risk. In fact, there is no shortage of studies predicting a boom in spending on risk management technology by the securities industry.
In June, for example, Boston-based research firm Celent projected that risk-related spending by financial institutions on governance, operational and compliance activities will grow at a compound annual rate of 6.6 percent, rising from $1.4 billion globally in 2008 to $1.7 billion in 2011. The bulk of the growth will come from software and services, Celent said.
According to another recent study from Aite Group, "Risk is Not Just a Four-Letter Word," the market for buy-side risk analytics alone is expected to grow from $1.25 billion in 2008 to $2.2 billion by 2013 ( see chart).
The report says volatility in all asset classes has shown a "pressing need" for comprehensive risk analytics, meaning systems which can analyze risks across different asset classes, from equities to debt to alternative investments, plus the ability to use VAR techniques (value at risk), measure sensitivities to different market events and exposures that result. The systems also should be able to stress test the effects of catastrophic events, such as a sudden 10-percent drop in market prices or a repeat of 9-11.
Denise Valentine, senior analyst specializing in securities and investments at Aite, says risk analytics is taking on a new urgency: "Risk managers are realizing that they need a toolkit, and it needs to be reviewed all the time."
Yet another study, released in July by consulting firm Accenture, surveyed 260 Chief Financial Officers, Chief Risk Officers and others with risk-related responsibilities, and found that 40 percent said their firms have increased or will increase their investments in risk management in the next six months.
Manna for Vendors
According to Aite, in the critical area of buy-side risk analytics, there are five leading providers poised to profit from growth in risk management spending: SunGard (product: APT), Algorithmics (Algo Risk), RiskMetrics (Risk Manager) MSCI Barra (BarraOne), and Blackrock Solutions (Green Package). "Robust buy-side risk analytics are needed now more than ever," says Aite.
Such optimistic projections are manna to IT vendors in the risk management space. And in fact, there are service providers who say they are seeing spending that matches the bullish numbers.
David Merrill, CEO of New York City-based portfolio analytics software provider FinAnalytica, says sales at his firm are up 200 percent for the first six months of 2009, compared to full year 2008. While Merrill said he did not have permission to mention any client names, he said they were buying the firm's Cognity software risk analytics suite. "A lot of systems are based on normal distributions. Ours is based on a fat tail distribution. We have a different approach," he said. The "fat tail" approach accounts for extreme market movements like an oil shock.
Still, Merrill believes that Europe is ahead of the U.S. in its deployment of risk management systems. "In Europe, the risk teams are larger and have more power," he says. "The regulatory regimes are built in. U.S. firms will need to step up to make sure they do not lose competitive advantage. There is pressure on the buy side to demonstrate expertise in [risk management] processes."
Notwithstanding Merrill's optimism, many other risk management vendors--including two in the buy side analytics area--say clients are taking a wait-and-see attitude about risk management spending.
Hitting the Brakes
Mark Coriaty, director of professional services at Boston-based hedge fund service provider Eze Castle Integration, is so far seeing little of the projected spending growth among his client base.
"Our clients--who are mostly hedge funds--put compliance and risk together. The in-house CRO will manage all data," he says. "We are seeing CCOs [Chief Compliance Officers] and CROs [Chief Risk Officers] hitting the brakes and looking at their environment from a compliance viewpoint. We are seeing a trend toward analysis and evaluation. Then, government is throwing a curve ball with [increased] transparency and registration--all the rules that will be laid out."
A big step for hedge funds will come when the SEC requires advisers to hedge funds to register, which is expected to happen later this year. "Something will get passed--but the key bullet points are unknown," Coriaty says.
In this environment, purchasing decisions are being put off. "It is similar to buying furniture for a house you don't own. There are definitely some parameters that are unknown," he adds.
RiskMetrics, a risk management research firm and solutions provider, is one of the dominant players in risk analytics. Gregg Berman, head of RiskMetrics' institutional and wealth management offerings, says that he sees different trends from different players in the space. Large sell-side institutions, such as Goldman Sachs, are "revisiting all the old assumptions they have made," he says. Brokerage firms, prime brokers and others that manage other people's money are "worried about the underlying risk of their clients--that has been a shift," he adds.
Still, he sees no rush to spend on technology. "Folks are still trying to get out of the mess they are in today before making future commitments," he says.
Marcus Cree, head of the North American risk solutions group at Wayne, PA-based software provider SunGard Data Systems, is similarly guarded. "The reason that you may not be seeing the spend that is potentially out there is [the view that] we need to get this conceptually right and not build it up piecemeal again," Cree said in an interview.
SunGard's offering is Adaptiv, a modular suite of enterprise-wide risk management and operations software. Asked where he sees concrete spending going, Cree says "You will see a move toward risk frameworks that make use of what was actually working."
What about the regulatory environment? "In terms of the spend, I am not sure that is the stumbling block," he says. "It doesn't hold up the decision. What holds it up is needing to know what went wrong and how we can make sure that the solution actively insures against that happening again."
While Cree says he is "starting to see the uptick we expected," he doesn't think clients are seeking wholesale changes: "We will not see major firms buying entirely new applications," he predicts. "Will you see a big bang moment? No. You will see component bolstering."
This story can also be found at SecuritiesIndustry.com.
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