Risk and compliance issues top agenda for software providers to hedge fund industry

As new regulations come into force for hedge funds, more information will need to be collected and formatted for use in compliance and risk reporting both internally and externally to regulators.

One property that risk has in common with other four-letter words is the wide range of different interpretations attributed to it. So anyone hoping to provide the technology system to support the risk and compliance needs of hedge funds has to deal with this ambiguity.

“It’s very difficult to have a one-size-fits-all risk system,” says Rob Keller, director of global product management at BNY ConvergEx’s Eze Castle Software.

“Everyone views what they consider to be risk differently. Some clients will consider real-time profit and loss as a risk system but others need factor-based analysis of their portfolios and want to see their exposure to various risk factors. And there are all kinds of shades in between.”

Eze Castle Software provides a risk module within its overarching order management system (OMS). “We’ve taken an approach where we have our own offering that allows clients to value positions and run scenarios to see how their portfolios might perform in different market conditions. That’s on a real-time basis.”

But Keller says some clients want more, so providers need to be honest about their own limitations and spot the gaps to make it easy for clients to fill in those holes in the service.

To cater for this, Eze Castle has built a framework that allows clients who need more advanced risk calculations to communicate their positions and terms and conditions in real time to other providers such as Investor Analytics, Risk Metrics and Portfolio Science, which are also involved in the risk and compliance reporting functions for hedge funds.

The challenge is to get the data for advanced risk calculations to those providers and then receive their calculations straight into the OMS for everyone at the hedge fund to use.

“We realise that clients will always want their choice of other systems. So we’ve invested a great deal of effort into building a robust application programming interface (API), which allows different software to communicate. If a client is using another portfolio management system or another risk system, we have a robust API that allows them to seamlessly integrate with that system,” explains Keller.

However, some aspects of risk and compliance are more open to interpretation than others, requiring more input from humans, not just electronic links between software programs and providers.

“We’ve got an internal group of consultants who are experts in compliance. It is part of the whole service model so clients don’t get charged extra for this,” says Keller. “Our compliance consultants will meet the clients to review their rule sets. We do this by working closely with [the hedge funds] to make sure they agree on an interpretation of any new rules and then make sure these are reflected in the various aspects of their OMS and implement them effectively,” he adds.

Rule changes need to be put into practice without interfering with the trading system, which comes as part of the overall OMS package from Eze Castle Software. This is another challenging area, admits Keller.

“On the compliance front, clients are looking for us to quickly adapt to new regulations,” he says. An example of this is the compliance requirements around Ucits hedge funds where there is extensive pre- and post-trade compliance. Such compliance needs to be implemented quickly and without disruption to the trade work flow.

“We spend a lot of time on the architecture to make sure it is as flexible as can be. As the rules change we can implement them quickly and without interruption to performance (speed) and work flow. You wouldn’t want to put the order in, have to wait a few seconds for it to say it’s OK or not. It happens immediately. We’ve made sure that happens,” states Keller.

One of the big issues coming up over the next 12 months is the move of many over-the-counter derivatives products on to electronic exchanges for central clearing. Keller thinks this could prove a challenge in terms of communicating the details of trades in these products to the information systems of other service providers such as prime brokers and fund administrators.

“One of the technology challenges will be how you communicate the details of some of these derivatives to the swap execution facilities that are being mandated as well as the central counterparties. That will require some enhancement to our technology to be able to communicate the different attributes of the trade,” Keller explains.

Risk and compliance management solutions
Eze Castle Software (15.0%)
Risk Metrics (11.5%)
Misys (10.8%)
HedgeOp (10.3%)
Investor Analytics (10.1%)