Facing extreme market conditions and imminent regulatory changes, banks and hedge funds need to adapt to changes in transparency, risk management and diffusion, according to a report fr
Facing extreme market conditions and imminent regulatory changes, banks and hedge funds need to adapt to changes in transparency, risk management and diffusion, according to a report from Tabb Group.
According to the report, entitled The Enterprise Spreadsheet: Pushing towards Transparency, transparency will come in the form of additional regulatory reporting requirements and the need to make improvements in enterprise data management efforts.
Risk management will focus on gaining a better understanding of market risk and operational controls, rather than ‘know your client’, ‘know your counterparty better’.
Adam Sussman, Tabb Group’s director of research and author of the report, says that as academics bicker about the validity of value-at-risk, ‘measurable improvements must be made to operational controls to detect frauds like the Madoff Ponzi scheme and prevent rogue employees like Jerome Kerviel from jeopardising a firm’s bottom line’.
Drawing on recent Tabb research, nearly 60 per cent of the buy-side participants interviewed said counterparty risk is now an important part of trade-allocation decisions. Despite waves of consolidation and contraction as firms collapse or, to survive, merge, there is an undercurrent of diffusion as firms mitigate their reliance on counterparties, spreading their business among more companies.
As a client request becomes a trade and a single trade becomes a steady revenue stream, says Sussman, banks must imbue this new product with regulatory, compliance, operations and risk safeguards.
‘We’ve moved from the sandbox to the stadium, where tension between flexibility and control begins to sprout,’ he says. ‘Moving from the front to the back office, the types of requirements lurch from flexibility and openness to standardizations and control, from spreadsheets and desktops to applications and servers. But this is a false duality.’
Armed with high expectations and wide jurisdiction, Sussman says the eventual creation of a risk regulator will bring demands for an in-depth look at the instruments on the books of banks, hedge funds and anyone else trading OTC derivatives and other unregistered securities.
However, according to Tabb research, with customization driving 60 per cent of the OTC derivatives market’s participants, implementing a more tightly managed environment should not impede innovation.
Microsoft Excel, says Sussman, is ‘a ubiquitous application on the trading desk because it’s so flexible, allowing traders to easily structure and calculate an instrument’s price’. Based on Tabb research, 47 per cent of the buy-side use Excel to price OTC options and 41 per cent use it during the post-trade process.
As trading risk increases, ‘it becomes difficult for a desktop-based product to satisfy the requirements of an entire enterprise’. Spreadsheets are often equated with manual, less sophisticated processes and as functions, processes or business lines becomes more mission critical, they move to a more formal environment, but Sussman believes that ‘this approach oversimplifies the issue. Spreadsheets, either alone or in conjunction with other components, can meet the same requirements as a business application.’
Further, he says, Excel has been embedded in many critical components of capital markets, but by always being tethered to the desktop, its ubiquity was accepted though perhaps not welcomed.
‘With the advent of better enterprise controls and support of high-performance computing, seeing a spreadsheet as part of an application framework is no longer foreign or scary.’
‘Regardless of whether a brokerage firm services institutional investment managers or retail clients, the rules of engagement are changing,’ Sussman says. ‘Similarly, whether an investment management company is running a 1940 Act fund or a private investment vehicle, increased disclosures and fiduciary obligations will be required. While Tabb Group does not believe that any part of the financial landscape will be legislated out of existence, regulatory requirements among different entities will converge.’
Tabb Group is a research and strategic advisory firm focused exclusively on capital markets.
