New regulations are driving significant changes in risk management systems and processes - and financial institutions need to ensure their technology is flexible enough to respond, according to Tony Webb, director of analytics at Fincad, at British Columbia, Canada-headquartered risk analytics and derivatives risk management software provider.
Regulators across the globe are working to implement a Group-of-20 pledge to clear all standardised over-the-counter derivatives through a central counterparty and to report transaction-level data to repositories. Meanwhile, several countries implemented Basel III on schedule from the start of 2013, which - among other things - requires banks to meet a credit valuation adjustment capital charge and comply with new liquidity ratios. Other jurisdictions - US and Europe among them - have not yet implemented the new Basel framework, but have pledged they will.
Taken together, the rules will create significant challenges for financial market participants, says Webb.
"The big impact is the need to post collateral now. There is a massive, greater requirement for assets to be posted, and there is going to be a lot of emphasis on making the best use of available capital and also taking into account correlation and cross-netting in order to minimise the amount of collateral needed, in order for the exchanges or the clearing houses to be competitive with each other," he says, speaking in a sponsored video interview with Risk.
"Of course, this is going to make the use of derivatives more expensive for end-users. The banks are going to have to pass on the cost of funding collateral, and the cost of counterparty credit risk is going to get passed on to the end user, so it is going to be more expensive, and we'll see what impact that has," he adds.
The financial crisis and subsequent regulatory changes have highlighted the importance of risk management, and has meant chief risk officers now typically more direct contact with the chief executive and board, says Webb. However, it also means firms need to take a flexible approach in their technology.
"Flexibility is the name of the game," he says. "We think it is important to build a platform with an object-oriented design, where the concepts are generalised as much as possible, and then specific implementations can be reused or replaced as new industry viewpoints emerge. But as long as the object framework has the correct abstractions, as time goes by and the industry develops its way of thinking about these things, then different implementations can be inserted or replaced."