Software survey 2002 |

Some online risk management products failed to live up to expectations last year, but software vendors forge ahead, developing products that support fast-growing markets such as credit derivatives and CDOs, and tools to help banks meet Basel II requirements.

Basel II will shape much of the way risk management software develops in 2002. Software suppliers say the new capital Accord is the biggest concern among their customers, and many suppliers’ attention has shifted towards providing new functionality to manage credit risk, the primary focus of Basel II.

Meanwhile, following the burst of the dotcom bubble and the failure of some online trading platforms and risk management service providers such as Cygnifi, the industry has a more tempered view of the internet for its business activities. But the internet and its associated technologies offer real benefits, and software suppliers are exploiting these to provide wider access to their applications, as well as improving processing efficiency and reducing costs.

The suppliers are also responding to the growth of markets such as convertible bonds, collateralised debt obligations (CDOs) and energy with new or enhanced products to support the trading and risk management of these instruments. Other areas where the industry is demanding extra technology support include the new FAS 133 and IAS 39 derivatives accounting regulations and fast scenario simulations.

Suppliers are working against a background of economic downturn, where IT budgets are being further constrained by the diversion of resources away from trading and market risk projects towards operational risk and disaster recovery arrangements post-September 11. This could lead to even fiercer competition among software suppliers in the coming year, especially in the less mature areas of the market such as the buy side.

These are some of the findings of our annual survey of new and upgraded derivatives trading and risk management software. Risk looked at the new versions or products that more than 80 suppliers released in the past six months, and those they have planned for the first half of 2002 – the listings begin on page 103. It also asked suppliers to identify the most important trends in the market-place for software last year, and those they think will dominate 2002.

“Throughout 2001, banks grappled with the implications of complying with the evolving requirements of [Basel II], in particular the advanced internal rating-based approach, across all exposure classes and business units,” says Michael Zerbs, vice-president, research and product marketing at Toronto-based Algorithmics.

To help banks comply with the emerging regulations, the software suppliers’ trading and risk management applications must offer a number of features, says Zerbs. They must support credit approval, pricing and limits management, and be an integrated part of daily risk management and reporting processes. They must link with banks’ internal models for capital adequacy and reserves and profitability. They must support stress tests across a wide range of factors, including market shocks and downturns and various liquidity scenarios. And for Pillar 3 of Basel II, they must provide “transparent disclosure with respect to key inputs and outputs”, says Zerbs.

Algorithmics is among the many suppliers that have, or are planning to, enhance their support for credit risk management. It has upgraded its credit risk and limits management modules, introduced Algo Credit eValuator for loan valuations, and plans to launch a dedicated Basel II module this year. Other suppliers focusing on this area include Hawaii-based risk and asset liability system supplier Kamakura, London-based enterprise risk management system supplier Misys International Banking Systems, New York-based SunGard Trading and Risk Systems, with its Credient online credit risk and limits management service, and California’s Barra, which aims to add potential future exposure-based credit risk analysis to its TotalRisk enterprise risk management system this year.

Basel II proposes specific recommendations for capital adequacy and operational risk, and encourages analytical approaches to exposure measurement. The industry is still in the early stages of gathering op risk data and creating analytical models, and few software products support this.

Our survey includes information about planned applications from Algorithmics and London-based Amelia Financial Systems, which intends to launch a system called OR2Q to combine support for qualitative and quantitative approaches to op risk management, and which will also be available as an integrated module of Misys’s Risk Vision system. London-based Raft International also recently introduced Raft Radar, which supports a qualitative approach to op risk.

One way to minimise op risk when processing transactions is to introduce straight-through processing (STP), which reduces manual input of data and thereby the risk of errors. By automating processes, STP also improves efficiency, and can reduce costs. A number of suppliers have been improving their STP capabilities, including Stockholm-based Front Capital Systems, with its Arena cross-asset trading and risk management system, and New York-based Summit Systems, which has enhanced its STP Operations back-office workflow product. Treasury management systems suppliers, meanwhile, have been focusing on providing STP links to the emerging online foreign exchange and other trading platforms, such as FXall and Atriax. Pennsylvania-based FXpress has added interfaces for individual bank and multi-bank portals to its forex exposure management and back-office system, while California-based Integral Development enhanced its Integral Direct technology for integrating trading portals with firms’ in-house systems.

The internet can improve STP across the industry by providing open and affordable electronic links between the buy and sell sides and third-party trading platforms. But this potential became somewhat inflated over the past 18 months or so, with suggestions of e-commerce sweeping away traditional business models. Now the dotcom bubble has burst, suppliers seem relieved at the new realism with which the industry now regards the internet. “The hype is gone and things have come back down to earth,” says Ravi Jain, chief executive officer at New York-based analytics and technology services supplier Egar Technology. David Aaron, senior vice-president of sales and marketing at Chicago-based analytics supplier Derivatech, agrees: “There was a lot of hype around e-commerce at the beginning of 2001, but the level of excitement has subsided.”

Now financial organisations and their software suppliers are looking less to revolutionise their operations with e-commerce platforms and instead are attempting to “merge their traditional and new economy technologies”, says Jain. This is being driven by the need to reduce costs and improve trading, transaction processing and other capabilities, says Allen Whipple, managing director of Summit’s business centre.

“In a tight market, institutions will experience competition for customer loyalty,” says Whipple. “The winners will offer demonstrable improvements in the quality and depth of services they can provide to their clients. One way they will accomplish this is to take the technology lessons learned from the e-commerce movement and apply what worked to their core businesses. Instead of frivolous, questionable services, we will see competitive firms implementing internet technology to deliver traditional banking services and products in a faster, more secure and more cost-efficient manner.”

The drive towards cost efficiency has become stronger with the downturn in the global economy, and while this is leading to greater demand for STP and internet-enabled applications, it is putting constraints on technology spending, although some suppliers may nevertheless still benefit, says Ken Price, vice-president, worldwide sales at London-based data services and trading and analytics applications supplier Monis Software.

“The state of the global economy will directly affect the success of the financial markets, and subsequently their profitability and appetite for expenditure on new systems,” says Price. “But in some cases, purchasing systems and services is less expensive than in-house development, which will positively affect some vendors.”

Rich Tanenbaum, partner at New York-based Savvysoft, which, like Monis, has evolved from a specialist derivatives analytics supplier to also provide data and trading systems as indicated in our survey, believes the current market conditions put Savvysoft, Monis and similar companies on course for a head-on collision with some of the suppliers of larger-scale systems.

“A trend for a couple of years has been for vendors of pricing models to expand their offerings and release systems with portfolio management capability at correspondingly higher prices than their pricing models, while vendors of large expensive systems with these capabilities lower their prices to compete in a more crowded market-place and a slowing economic climate,” says Tanenbaum. “We expect that in 2002 these two freight trains will crash into each other as their features overlap and prices converge.” Which suppliers will survive remains to be seen.

Analytics suppliers must also ensure their models reflect the new economic realities, warns Teri Geske, senior vice-president at Los Angeles-based fixed-income portfolio analytics supplier FT Interactive Data (formerly CMS BondEdge).

“The [US Federal Reserve’s] unprecedented rate cuts post-September 11 also affect fixed-income risk managers and software developers,” says Geske. “As interest rates have declined to near-historic lows, there is the increasing probability that term structure models, Monte Carlo-based interest rate path simulations and other pricing algorithms will cause future cashflows to be discounted at negative interest rates. While one may debate the theoretical validity of such computations, software vendors may have error checks designed to prevent this from occurring. Thus, models that may have been coded years ago will have to be examined for appropriateness in today’s environment.”

Conditions in the US economy and elsewhere are also driving the growth in markets for certain instruments, and consequently a demand for technological support for the trading and risk management of those instruments. Paul Gardiner, director of marketing at California-based cross-asset processing system supplier Calypso Technology, says that as equity volumes have shrunk, firms are turning to areas of the market still making money, most notably equity and credit derivatives. “Firms are still willing to invest in [technology for] these areas,” he says, and Calypso recently added support for credit derivatives, as has Paris-based Murex. The trading and risk management systems division of Reuters, based in Paris, plans to introduce a credit derivatives module for its Kondor+ system this year, while London-based Lombard Risk Management aims to release a credit derivatives application as a stand-alone product or run with its Oberon multi-currency trading system. Lombard believes the trading of these instruments will be increasingly important for firms meeting Basel II requirements.

A number of suppliers have also been enhancing their support for trading convertible bonds and collateralised debt obligations. Price believes convertible bonds have come of age, and where once Monis was one of only a handful of suppliers that offered analytics for these instruments, our survey reveals a number of suppliers have now added support to their systems, such as Vancouver-based FinancialCad and Illinois-based Wolfram Research, while New York-based analytics specialist NumeriX plans to introduce an equity derivatives valuation and risk management application this year.

Other growth markets where suppliers are developing technological support include CDOs and energy trading. “Having become a general banner that encompasses any restructured pool of heterogeneous assets – distressed debt, equities, mortgages, hedge fund portfolios – the CDO presents myriad challenges for a collateral manager,” says Peter Bernard, executive director of New York-based risk management data and analytical applications supplier RiskMetrics. “Typically, senior level securities within CDO structures are sold on their high credit rating, mid-level securities have been sold on yield, and low-level or equity tranches have often been kept by the collateral manager. To maintain a profitable balance within the CDO, two risk/structuring issues have surfaced – many investors only vaguely understand the characteristics of the pool they are buying, and as the structures themselves become more varied, managers will require more sophisticated models to evaluate them.”

RiskMetrics is rebuilding its CDOManager application, which will model and optimise CDO structures, to run over the Web. New York-based Derivative Solutions plans to release a similarly titled application this year.

Three suppliers recently entered new systems into the burgeoning market for energy trading. Kalahari, based in Surrey, England, launched an energy version of its Kalahari Advanced Calculation Environment pricing and analytics systems, called k.A.C.E. Energy. GFInet released Fenics Energy, an energy options pricing application based on its established forex product, which incorporates market data from GFI brokers, and Raft introduced a global limits and exposure management application for the energy markets, which will interface with multiple front- and back-office systems to measure and monitor credit exposures.

Other areas where software suppliers have been extending their applications include supporting the new FAS 133 and IAS 39 derivatives accounting regulations, improving scenario and Monte Carlo simulation functionality (especially post-September 11), and introducing new products for the buy side, such as the Fame Internet Data Service of financial and energy data from New York-based Fame, and the PerfectVine trading and risk management application for hedge funds from London-based Xenomorph Software.

Operating systems on which the applications run is a far less contentious issue than in the past. Most applications will run on Microsoft Windows and Unix, sometimes with one part, usually the server component, running on a Unix machine, while the user interface, or client component, runs on Windows. But a quarter of the suppliers in our survey offer their software on Windows only, and three restrict their products to Unix. However, with a growing need for systems integration to gather risk data from across the organisation and to achieve straight-through processing, suppliers must ensure their applications can link to and operate within a heterogeneous technology environment.

Many operating system compatibility problems are solved by using the internet and its technologies for creating and deploying applications, particularly the client components, because they use standard browsers. Java also avoids compatibility issues. It is both a programming language and an operating environment, and will run on most hardware. It was also designed for operating with the internet.

Suppliers are increasingly turning to Java 2 Enterprise Edition (J2EE), particularly those building large-scale, high performance applications, such as Calypso, Raft, and Integral Development and Iris Financial Engineering & Systems, both based in California.

Microsoft recently introduced a set of technologies under the .Net umbrella to compete with Java. As .Net is still under development, only one of the applications in our survey – FinancialCad’s Fincad.net financial applications development toolkit – makes use of it so far.

Microsoft also introduced a new desktop operating system, XP, and about half a dozen suppliers, including Zurich-based Iris Integrated Risk Management, London-based MB Risk Management and California-based SunGard Treasury Systems, have already ported their software to it. Meanwhile, around 15 suppliers have ported their applications to Linux, the free, public domain version of Unix. This includes New York-based Axiom Software Laboratories, London-based Tamesis and Anvil Software.

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