Prolonged market turbulence is pushing buy-side firms to strengthen risk frameworks and systems and look for new ways to securely and effectively operate their businesses, according to a new report by financial consultancy Celent.
For institutional investors looking to withstand future volatility, the need for a robust investment risk management system is now seen critical as structural market, regulatory, and business trends now place direct demands on firms to strengthen operational and technology underpinnings, said Cubillas Ding, research director at Celent and co-author of the report titled, ‘Derivatives and investment risk solutions for the buy-side: Optimising the risk-return equation’.
“These firms are looking for a cohesive approach to integrating investment risk management processes strategically into their portfolio construction, trading, and enterprise risk architecture,” said Ding.
Many long-term investors have de-risked their portfolios in response to regulatory and accounting changes, including a move towards mark-to-market accounting and stricter capital requirements, as well as a lower institutional tolerance for risk, asserted Ding. The shift has led many buy-siders to increase buffers of liquid investments, with some institutions shunning illiquid investments altogether and reducing the capital allocated to risky and volatile assets.
“There is a clear focus on enabling and enhancing risk systems to measure and monitor market, counterparty, liquidity, and credit risk on a total portfolio basis,” said Ding. “The ability to monitor all exposures will allow firms to respond swiftly to any form of counterparty credit deterioration, while various functionalities such as liquidity risk management capability and a comprehensive set of risk analytics and attribution will provide firms with the ability to understand their liquidity risk and firm-wide exposures at all times.”
As part of the study, Celent evaluated six vendors of investment risk systems – Algorithmics, Calypso, Misys Sophis, MSCI RiskMetrics, Murex, and SunGard APT.
When looking at present offerings, Ding said end-to-end solutions tended to be limited in their risk analytics capability, often lacking multi-factor modelling capability. Even where multi-factor modelling was present, most solutions only offered pre-specified/structural models. Stand-alone systems allowed more flexibility and robust modelling capability, with statistical modelling techniques allowing for the estimation of systematic components obtained directly from historical data.
Ding said there was a need for stand-alone systems to integrate and align risk management workflow with front-, middle- and back-office functions.
“Integration between the functions should be seamless, and a stand-alone system should be able to monitor exposure on a real-time basis and provide a consistent valuation framework,” Ding said.
MSCI, Algorithmics and SunGard scored well for their strong track record of advancements in modelling capability, extensive risk analytics, and comprehensive risk attribution capability.
Misys Sophis and Murex stood out for their wide range of instrument coverage, cross-asset support and integrated approach to risk monitoring, while MSCI and SunGard had the largest buy-side client base among the analysed vendors.