For much of the world the holiday season is still a few weeks away, but in the United States with Thanksgiving fast approaching, it is nearly upon us (cue stress levels and scales rising). Thanksgiving is time for family and reflection sure, but let's all be honest... the part of the holiday that has most of us salivating is the feast.
Like those hungry holiday guests whose plates are piled far beyond their ability to tackle in a single sitting, risk managers in the OTC derivatives space have quite a lot on their plates these days. Moreover regulators and the markets are always at the ready with another heaping scoop of new challenges that aren't quite as nice or enticing as the rich and buttery mashed potatoes Mom makes each year.
So we explore what's driving risk appetites this Thanksgiving and the challenges that face risk managers now, and in the year ahead:
Just like the turkey on this year’s Thanksgiving table, regulation continues to take center stage. With a range of Basel III bank capital regulations still “roasting” the standardized approach to counterparty credit risk is set to come in to effect January 2017. While the CVA risk framework is undergoing a proposed revamp, BCBS aims to finalize the FRTB policy framework by end of 2015, and the ISDA Standardized Model for Initial Margin has banks around the world asking “Quick- what’s our SIMM approach?”
In a surprising turn, the European Commission revealed just this month that perhaps the most ambitious of all post-crisis regulations –the MIFID II securities reform might be pushed out until 2018. Europe edges towards mandatory clearing of its over-the-counter derivatives markets from April 2016, and the CFTC hopes to finalize uncleared margin rules this December, leaving just nine months before implementation. Lastly but not least of all, Insurers all around the globe will also be watching carefully as Solvency II takes effect in 2016.
Mashed potatoes aren't the main event, but in a way they pull the whole meal together. It's a classic recipe where simple is often best, but when it goes wrong or is missing from the table you’re sure to hear about it. For a long time the recipe for risk technology infrastructure has been an amalgamation of latency systems stretched far beyond their limits. Often siloed and entrenched in duplicate processes these risk system can be expensive to maintain in terms of human, compute and data costs.
Risk managers know well that to uproot entire legacy systems in one fell swoop is often unrealistic. The Risk 2.0 recipe leverages a "Planned" Risk Infrastructure approach. This means they'll be tackling one system at a time to address the needs of the present and reverse the shortfalls of the past, all the while ensuring a clear game plan for the future - which for now means enterprise risk analytics and real-time risk.
With evolving regulations considered key drivers behind the new era of real-time risk management, a strong trade profitability framework that brings the XVAs into trading decisions is undoubtedly a key accompaniment, and healthy addition to our Thanksgiving risk plate this year. Many firms are transacting derivative trades without understanding the full profitability picture – including risk charges, capital and funding charges, and other XVA adjustments. And in the current market environment, institutions simply cannot afford to take this risk. Like our green beans, understanding and managing trade profitability with a complete understanding of the costs associated with the trade lifecycle may be the best choice you make all Thanksgiving.
As institutions move towards adopting more unified analytic approaches for enterprise level risk management this in turn has created massive amounts of data. While the cranberry sauce to some may seem like an afterthought it’s really the thing that brings everything together. In today’s market actionable intelligence is needed in real-time – as such risk silos, data processes, and analytics must be thought of in a holistic manner as opposed to separate entities. Through the instant analysis, aggregation and visualization of large volumes of complex and dynamic data decision makers can compare results over various time periods, make what-if inquires and achieve a timely, more accurate view of risk enterprise-wide. Through this process calculations are consistent and meaningful for business decisions, not just for regulatory compliance.
What would Thanksgiving be without a dessert, or two? Though apple pie is the quintessential American standard, on Thanksgiving pumpkin pie is the spice filled sweet that pushes this day of indulgences over the top. For risk managers the impact of the global markets hasn’t been the perfect ending they envisioned. Instead a host of complex challenges have spiced up the way they’ve had to understand, model and adapt to risk. In 2015 alone we’ve seen incredible volatility swings in the equity market, huge dives in the commodity sector, and sustained low and even negative rates with no sign of change ahead. Risk managers need to be more prepared across the enterprise for the next impacts of a global marketplace – from dynamic stress testing capabilities to thorough and timely model validation techniques.