Asset managers should change their attitudes to counterparty exposure, bringing the responsibility in to the middle-office, according to a Fidessa paper.
The paper, by Steven Strange, a compliance product manager at Fidessa, noted that buy-side firms are starting to pay more attention to their processes for monitoring and controlling counterparty risk, many of which they are finding to be inadequate.
Good credit is no longer enough to establish a counterparty’s fitness as a trading partner, Strange suggested, and regulators expect risk to be aggregated across asset classes, including holdings that may not have been considered previously.
At the same time, clients are more demanding as they try to mitigate their own risk, and are no longer satisfied with manually-generated reports.
Strange said in the paper: “Aggregating risk is much more difficult now, when a given counterparty could be any (or all) of: an issuer for a security within the fund; an indirect issuer for a security within an index or ETF; or a counterparty to another trade in a different system.”
Calculating exposures is also more complicated, Strange suggested, considering the numbers of asset classes, and hedging and netting arrangements.
He pointed out that some firms still use daily limits supplied manually, with trades calculated and deducted throughout the day, while others use end-to-end operations teams to extract data from multiple trading systems before sending results to risk teams.
Strange said: “This broadening and deepening of complex manual systems is clearly unsustainable. Fragmented processes and systems across regions, asset classes and acquired firms add even more layers, all of which is an anathema to achieving the control that firms – and regulators – want, and clients demand.”
Asset managers should take steps to better protect their firms, Strange suggested. Transferring decision-making from trading operations to compliance and risk management teams could give senior management a more holistic view of counterparty risk, he said.
Firms could also select a single point of implementation and monitoring, supported by an automated process. While being more cost-efficient, this could also improve auditability and recall, and means controls could be put in place more pro-actively and in reaction to changing conditions, Strange said.
Finally, technology systems should be flexible with robust counterparty assessment capabilities, with sophisticated risk calculation using different metrics and asset classes. They will also have to integrate easily with order management systems in the front office, while providing data to the middle office.
Strange said: “In this way, breaches of counterparty risk limits can be prevented before they occur, and burdens are lifted from trading, risk, compliance and administrative staff.”
“Forward thinking asset managers are becoming ‘counterparty intuitive’ to everybody’s benefit. And this means they not only run better operations, but also position themselves to win more business and maintain their competitive edge.”
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