Top Stories of 2014: Risk's Multiple Tech Vectors
Market, counterparty, credit, liquidity ... operational, cyber ... what's next?
Risk isn't uncertainty alone. As the economist Frank Knight once wrote, it's actually randomness in which events have measurable probabilities.
In other words, risk is defined by quantification—and likewise, one can assess the business of managing a particular risk by the contour of conversation around its underlying technology. Waters did quite a bit of that work in 2014.
This year, we heard intriguing chatter in some quarters, and noticeable quietude in others—but overall, the different directions risk can now shoot continue to be overwhelming for risk managers and the technologists who support them, alike.
A review of Waters content from the last 12 months reveals, for example, a spike in offerings and products geared towards hedgers, particularly in the swaps market but also in cross-asset trading. It also shows we still don't entirely trust the outside world, either—from measuring counterparty risk more carefully, to technology as a risk now being firmly on executives' minds, as their companies try to steward reputation and protect proprietary data.
On the other hand, we stopped hearing the well-tread phrase "real-time" risk quite as much. Ditto for the discussion of kill switches, which seemed to withdraw a little bit as the industry came to its senses—or at least enjoyed a year without a major algorithmic meltdown on an exchange. Their proponents will say it's not the first time this topic's drifted away ... just wait. And if they keep saying that long enough, well, they'll probably be right. Eventually.
In the meantime, here are a half dozen topics and trends Waters journalists identified, scrutinized, and dug into during the past year:
Swapstakes
Of course, the biggest deal in technology for the last few years—apologies, Flash Boys—is the overhaul of the swaps markets and much of the trading and risk management platforms underlying them.
But until 2014, it all seemed to be in a holding pattern. This year, electronification finally landed, and three themes seemed to build in momentum as months went on. First was the unleashing of market-agreed coupon (MAC) contracts, which are now available on a number of swap execution facilities and are designed for the crucial matters of portfolio compression and netting.
Second was swap futures' undeniable rise. That's especially true for Eris Exchange, which has now licensed intellectual property for Canadian and European products, as promised.
Finally, on the dealer side of things, swap execution facility (SEF) aggregation portals like UBS Neo took off, with some buy-side firms like Eaton Vance jumping in, and others like BTG Pactual taking a wait-and-see approach, but ultimately, we got to see the direction the sell side will be heading to stay relevant in the new environment.
Crossing Assets
Here's to the little guys getting helped out by the (really) big guys.
Another risk management-specific trend had to do with boutique fund managers taking new, expansive (and often fairly expensive) risk analytics and reporting offerings from giants like SunGard and FinCAD, which have focused on that segment with more concerted effort.
Even the sub-$1 billion hedge funds these days believe they need to tackle serious complexity to persuade investors of their fees and grow their capital. As such, the days of "simple" long–short equity seem numbered, and regardless of whether a single market is the primary target, even a little variety adds new risk management requirements. No reason to expect that diversification to slow down.
Valuation Adjustment's Alphabet Soup
Tech-intensive valuation adjustments like credit, debt, and funding valuation adjustments (CVA, DVA, and FVA) are here to stay as well, and pricing providers like Numerix are pushing beefy, sophisticated frameworks that came of age this year.
This is something of a turnabout from a couple years ago, when skepticism and distate for Basel III capital charges caused some sources to wonder if the "other" non-regulatory valuation adjustments would become widely understood, or if CVA would even stick around itself. Apparently so.
Real-Time, Out?
Before Jake Thomases left us to pursue some knowledge at Johns Hopkins, he wrote a great piece reminding readers of just how much we'd heard "real-time risk" in industry parlance in recent years—e.g. too much—and just how fraught (or even necessary) the concept might be. Definitely worth a read.
Buzz Kill (Switches)
Not to be outdone, Jake's successor Dan DeFrancesco reminded readers just this week of another conversation—exchange-based kill switches—that left us a little bit this year, too.
That's not to say that rogue algorithms or exchange blackouts don't scare people—indeed, the topic has migrated its way across the Pacific, and major operators continue to implement switches without much concern for the cost. It's just that after the height of industry concern around the issue following the 2010 Flash Crash and then Knight Capital collapse in 2012, these mechanisms simply couldn't sustain their steam in the face of internal and potentially more effective options.
Cyber a Four-Letter Word
Finally, there is technology risk, fully embodied and very infuriating. Cybersecurity took the mantle from mobile and graduated to business topic of the year in 2014, following a series of major breaches that started with a typical trip to Target and ended with Aaron Sorkin and half of Hollywood grumbling.
From regulators refining their approach to information security (and getting guff for it), to war game-like simulations taking hold in several jurisdictions, to C-levels tripping over themselves to say, "yes, frankly, this scares us," a conversation that was percolating someplace in off-the-record territory not so long ago is now on the top half of broadsheets.
Managing the problem makes PhD-level risk management stuff like convexity curves and funding valuation adjustment look, well, almost easy.
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