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Siag Risk Management: Speed Kills; Unless you keep pace with it!

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As Aldous Huxley commented; “Speed provides the one genuinely modern pleasure”. In a world where the speed of information increases exponentially approaching mere nanosecond lagging with cache memory processing and even faster data processing chips, the speed of important changes in data may be swamped and invisible within a morass of reports and systems where it becomes increasingly more difficult to identify the inconsequential from the vitally critical. This is the modern global market universe in which financial institutions exist.

Such a phenomenon has been commented frequently by Asymptotix with regard to cyberbot driven millisecond arbitrage trading which now accounts for 30% of overall market trading volume. Within substantial portfolios; 10% + of overall positions may be altered during the cycle of international trading on 140+ exchanges and over 10 million assorted instruments from the simple fixed income to the highly complex derivative. The greater this inevitable technological acceleration towards light speed; the more the exponential increase in Market Risk exposure becomes apparent as we approach Market Energy equalling this critical Data Mass times the Speed of Light squared; or as Einstein expressed it as a pioneering Quant E=MC².

Yet despite this frenetic exponential rate of chip inspired market velocity and acceleration measured at several million dollars or euros per second per second; the Deloitte 6th Edition Global Risk Management Survey of Global banks and investment institution showed that in 2008 27% of survey participants did not possess the figure of a CRO, and of these clearly optimistic and tremendously valiant organisations only 6% deemed it necessary to review this self apparent gap in their management structure at some unspecified point in the future. The other 21% we can assume are expert poker players upon whose indomitable bravery perhaps history or concievably another reciever will cast the final verdict.

Deloitte have also edified us that 23% of surveyed institutions are so bullishly valiant in fact, that they do not even consider Risk Management as an oversight responsibility of the Board of Directors. However, sadly we remain as in the dark as they are as to the identities of these risk heroes in order to take the appropriately informed decisions regarding appointing suitable guardians of our hard earned cash. Perhaps more alarming still, to the fiscally prudent, is the fact that those institutions having seen the perspicacious wisdom of possessing a “defined and approved enterprise level statement of the firms acceptable risk appetite” was an undeniably modest 12%;. 88% then apparently considering that the entire topic of their appetite for risk was a strictly private matter which their staff had no need at all to be concerned with.

The purpose of attempting to inject a modicum of irony into this patently weighty and pressing issue is purely to illustrate the extent of the key issue which regulators and auditors are trying to address via Basel II & emergent III, IASB and IFRS7 and a wave of new risk management orientated legislation and enforcement typified by the CNMV directives in Spain in December 2009. Spain is arguably the best and strongest regulated market globally. Not only with a key strategic focus on advanced risk management technology, management systems and substantial risk teams with clear risk and limit management protocols, but also through demanding the highest capital reserve ratios of banking institutions and thus providing an adequate buffer against risk appetite and downside market risk. Let us be clear here that we are addressing Market Risk, the most immediate, volatile and dangerous burner of the asset column in the GL and the primary china syndrome causal agent of the many unquenchable Neroesque descents into the ashes of insolvency and liquidity aridity we have seen over 2 years now.

Professional and effective Risk Management is not some nice to have but non mission critical optional extra in running a stable, prudent and compliant financial institution. It is a fundamental core tenet of international banking and financial institution regulation and it is quite impossible to exercise professional due diligence over the management of investors trust in placing funds to be managed in the hands of the professionals of the asset management sector without it. It is a complete abdication of the legally obligatory duty of care to not have in place the technology, management, culture and highest level operational supervision over the management of Risk within established limits, apetites, policies, and protocols. This compliance and duty of diligent care inherently demands the technology necessary to ensure that all data is validated and accurate and that risks are understood, managed and fully transparent, consolidated and aggregated in a timely manner allowing Risk Management decisions to be carefully considered and implemented within the global market determined volatility, pace and speed which now themselves dictate the performance of the required systems and protocols for compliance.

The defined primordial measurement of Market Risk is VaR and it is therefore pointless to debate what is inherent to correct regulatory compliance. VaR is not a single measure. It is a range of measures based upon, historical data, varance / covariance or parametric intraday data, Monte Carlo modelling, stress testing in a wide range of “What if?” scenarios and back tested to full portfolio revaluation consolidated and aggregated from instrument level to Group holding. VaR measurements are only reliable in their full analytical statistical diversification providing a complete view of Market Risk as determined by the probability of losses to a given degree of confidence over a specific temporal horizon considering multiple measures, a wide range of data sets and a full range of stress scenarios.

One type of VaR measure alone is as a chair with one leg – Of little practical use and entirely unsafe to place any weight upon. Modern technology systems are able even at the current speed of volatility and intraday market paradigm shifts of 10%, now within only one hour as we have seen recently, to fully analyse and accurately predict VaR on demand to a degree of accuracy in the upper 90% range. It accordingly remains impossible to comprehend why so many institutions neither have a CRO nor technology capable of predicting with close to 100% accuracy the actual value they have at risk and in precisely which positions these risks are being exposed. The ability to consolidate and aggregate this to Group level may be a recent innovation driven by step change leaps in the ultra fast computational performance of Tier 1 calculation engines; however the fact remains that this technology is now available and simply requires implementation alongside current front to back management systems.

Furthermore; extensive client feedback and sector purchasing trends show a clear shift from legacy technology to modern Enterprise technology solutions positioned around an ultra fast data platform, and even now in memory processing and Grid data volume handling capacity, as John Morrison has been coherently and insightfully arguing for a full year now. Why? Speed & Data Volumes.

In markets which are moving and contorting at racing speed just as the circuit of the Monaco F1 Race, there is very little point turning up to compete in a steam roller. It may be heavy, large and has the potential to flatten the overall race track to a smooth operational surface, however like the Behemoth that such systems are, when the modus operandi of the track demands 250 mph performance capability, agile handling and 0-100 acceleration in sub 5 seconds, of very little practical use is a racing machine weighing 20 tons with a top speed of 10 miles per day  with the turning circle of an oil tanker which takes up to 15 hours in an overnight batch process to calculate yesterday’s VaR. The eventual partial market risk reports reports from yesterday you might have sometime this afternoon but sadly a full 6 hours after todays volatile markets opened again and made your troubling risk weighted positions of yesterday a whole lot worse and much more expensive; or in terms of this analogy, the race has already finished and the champagne spraying from the victor when you eventually trundle and clank noisily and panic stricken up to the starting line from the pits a mere 6 hours late.

When you find out at 15:00 today that you had a Grand Canyon of a dent in the balance sheet at T-1 EOD yesterday caused by limit breaking positions consolidated and aggregated to weaken the entire portfolio somewhere in the world, unless of course you were one of the valiant 27% who see no need whatsoever to waste money which could otherwise be blindly risked by employing a CRO who may inconveniently raise an eyebrow with the Board as you sailed blithely towards insolvency; he or she would have almost certainly done something about this black hole immediately at pretrading T-0 today and removed these limit breaking postions before the market even opened and thus fully covering their risk teams salary costs for the next couple of milenia or so. A visionary soul may consider such sensible predictive investments even more reassuring than CDS default premia which are also cost spiralling to the point of coverage fees obviating potential investment profits precisely because of this mysterious and dangerous phenomena known as Market Risk. Is it better to accurately predict and through good risk management avoid the obvious risk early, or to try take out ever more expensive insurance just in case? Shall we leave this as a rhetorical question for due consideration?

Legacy dependant institutions not having had access to the helpful and some may even say necessary Market Risk Management insight from modern ultra fast systems, remain vulnerable to the steam driven Behemoth which is still grinding away manfully and very expensively in the corner to resolve the multiplication of 2X2 hopefully prior to your retirement. The dawn of revelation that the T-1 EOD Grand Canyon has now by 15:00 T-0 become the San Andreas fault is to many a deeply unpleasant surprise. This tardy partial analysis delivered at 15:00 today has a tendency to send unprecedented alarm and panic through your organisation; assuming of course that you have a CRO, as otherwise this realisation may escape one entirely until the bailiffs pop round for the furniture thus causing an addional deeply unpleasant surprise. Quite unseemly stress driven panic then spreads via osmosis with an alacrity which could only be paralleled by the engines on the jet aircraft on which you are travelling at 30,000’ appearing to have gone disturbingly quiet as you flew through the volcanic ash cloud; such troubling mechanical abnormality made considerably more concerning by the Captain popping up on the tannoy to ruin your day completely with the words; “Good afternoon Ladies and Gentlemen; Lifejackets on and Brace, Brace Brace”.......

It does NOT have to be this way. Market Risk Management Has Come Of Age.

This is what is technologically possible today. This is why Siag is aligned with the professionals of Asymptotix who understand Risk Management. Understand Risk Technology. Understand Regulation and Compliance. Understand why the solution to preventing a further crisis such as we have lived is not simply taxation. Taxation does not solve the core problem. It only addresses the symptoms and not in any way the cause of the “disease”. It is no more than useful in preventing further economic destruction than to fill your medicine cabinet to the brim with curealls “just in case” rather than take the vaccination which stops you falling ill from the known condition in the first place. 

The solution is Technology, Risk Management, Compliance, Systems and Protocols. This I would argue is the message and this message is patently clear to all who would prefer to gain the competitive edge of the available vaccination, rather than cough and wheeze their way back to the medicine cabinet again in the future hoping to find some kind of analgesic pain relief.

David R Bristow
International Director
Siag Risk Management

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