Installing a powerful risk-management software system is a bit like owning a horse. A horse may seem like a wonderful idea to a child, but if you try to keep one in the garage, and have to keep feeding it and mucking out its accommodation, you quickly understand that it might be better to stable the horse elsewhere. And when you realize that you are not getting a chance to ride as often as you hoped – and that the horse is getting long in the tooth – you may well conclude that you don’t really need your own horse, and that it might be a better idea simply to join a riding club where you can saddle up from time to time. Like horses, in-house risk-management systems and licensed solutions are extremely costly. Maintaining in-house systems or even installations of licensed software puts a burden on a firm’s IT organization. Only large financial institutions and major corporations that deal constantly in the markets have the financial resources to install such systems, the IT personnel to maintain them, and the transactional volume and portfolio complexity to require their use on a daily basis.
With the advent of e-finance application service providers (ASPs), the often-overburdened treasuries of moderate-sized firms and the smaller firms less active in the markets now have access to sources of market information, analytical tools and risk-management systems they could not previously justify purchasing. Some of these applications are intended to function as overlays for existing systems used by a corporate treasury or fund manager: they take position details from such systems and produce reports that facilitate compliance with FAS133 accounting rules or present a comprehensive VaR (value at risk) analysis, using vendor-supplied data. Even fairly large institutions and corporations may welcome internet-based applications through which an ASP relieves them of the problems of data capture and scrubbing.
For vendors, of course, the ASP model for delivering applications essentially eliminates problems of version control among diverse and far-flung customers. It makes it easy to introduce enhancements and keep up with new instruments introduced in the market or changes in reporting requirements. Most important, with consolidation in the financial services industry reducing the number of banking clients, hosted applications give vendors a flexibility in pricing that lets them reach a much broader potential market of corporate treasuries and asset managers. Diminished concerns about security and better technology for transmitting details of positions have largely overcome the main obstacles to clients maintaining portfolio information in databases residing on vendors’ servers.
Internet-delivered e-finance applications include private-label offerings from major commercial and investment banks, delivered through sites accessible to customers, and solutions offered by independent firms. Among the latter are hosted applications created by existing vendors of licensed trading and portfolio-management systems and applications created by bank spin-outs.
Available applications bring cost-effective sophistication not only to market risk but also to credit and operational risks, as well as to risk management of collateral. As corporations begin to deal quantitatively with such non-market risks – as banks are now obliged to by capital requirements – they will be able to tap a pooled database via the web, thereby gaining a much better idea of their exposure to loss from non-market risks. These hosted applications, normally used less frequently than applications aimed at market risk, will help firms judge which risks to retain, and to assess which investments to mitigate them are actually worthwhile, including the customary risk transfer through insurance premiums.
The products
Euromoney reviewed web-based risk-management solutions with varying functionality, ranging from comprehensive offerings to those designed for a specific application and market niche. Some had deal-capture and straight-through processing (STP) capability, others focused on post-trade portfolio risk assessment. Some hosted applications provided real-time data captured, filtered, and consolidated by vendors. Other applications, aimed at FAS133 compliance or VaR measurement, used end-of-day data. Even offerings designed for portfolio risk analysis showed marginal VaR and could be used for hypothetical positions and what-if simulation-testing. They therefore lend themselves to pre-trade use in strategy analysis, as well as to understanding the risks of existing portfolios.
Some of the products are relatively new, often at a beta development stage. The survey is not comprehensive. T6he ASPs have been selected to illustrate the scope of web-based risk-management products, and time did not permit the more exhaustive survey and active use of each application over a sustained period that would be required for a true buyer’s guide. In addition to providers of hosted applications, we also included a provider of libraries and infrastructure used by ASPs.
We contacted 13 such firms and asked them which on-line risk management services they provide for corporate treasurers and risk managers. Eight responded fully. We asked questions about the scope of each system and the details of functionality available in various categories: presentation of market data and pre-trade decision support, dealing and position housekeeping, trade grouping and portfolio organization necessary to support FAS133, as well as valuation, risk measurement, and simulation or what-if analysis. Since pricing of hosted applications is normally a function of frequency of use as well as the number and complexity of client positions, it was difficult for vendors to provide specific figures. Along with a tabulation of these vendor responses, we present below an overview of each solution.
NetRisk
NetRisk offers two products of interest to corporate treasurers, RiskOps and Crystal Box.
RiskOps comprises three modules for measuring and managing operational risk. Operational risk measures the direct and indirect impact of insufficient processes or technology, human error and fraud, and external events.
The first module, Data Collection, facilitates the collection of an institution’s operational risk loss events and operational risk factors for each subsidiary, branch, or department. The tool is compatible with MORE (Multinational Operational Risk Exchange, a non-profit corporation established by several leading financial services firms, with NetRisk acting as the managing agent) and ensures consistency of collection with pre-defined menus for the selection of event factors, such as cause or loss type.
The second module, Data Handling, enables the user to navigate through external and internal loss databases, containing over 3,000 operational risk loss events specific to the financial services industry.
Key slicing functions include:
pie chart views of loss severity and frequencies;
histogram of losses, both by amounts and quarterly time periods;
linear and non-linear, macro and micro-level scaling by such factors as total assets, market capitalization, number of employees and revenue;
date of loss event selection criteria;
minimum and maximum dollar loss selection criteria;
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hierarchical classification by cause, business unit or effect. The third module, Data Modelling, applies an actuarial-based methodology to the loss database to calculate the aggregate loss distribution. The user has the option to select data sets from internal, external, self-assessment and/or management scenario sources, and model the risk by cause, business unit, industry sector or loss type as a single model or combined model. Resulting loss distributions will provide operational capital-at-risk estimates at every confidence level.
“Although the data collected by NetRisk has been tailored for financial institutions, the software, the models and all the slicing and dicing are applicable to any market and any type of institution. If a corporation wanted to do an analysis of its operational risk based on its own data, others’ data, a scenario analysis, or a combination of these, the corporation could do that as well,” says Robert Ceske, managing director at NetRisk.
It is questionable, though, how many corporations will have the time and the commitment to take a product tailored for financial institutions and use it to model their own operational risks and it is unlikely that treasurers, as opposed to some other corporate executive, would receive such a mandate. On the other hand, as B2B market places and auction software transform traditional supply chains, more and more corporations are effectively engaging in commodity trading in a quasi-financial environment. As they deal more rapidly (often over the internet) and with a larger pool of market participants, their operational risks increasingly resemble those of financial institutions. So products that go beyond self-assessment, such as RiskOps, will definitely be of interest to the more sophisticated corporations with sufficient transaction volume to accumulate meaningful data.
CrystalBox, NetRisk’s other offering, is a reporting and analysis tool designed principally for institutional money managers, and is relevant to corporate treasuries that have responsibility for a company’s defined-benefits and defined-contribution retirement and pension plans.
Users can export data into CrystalBox from their existing accounting systems or other risk-management software. Its analytics enable the user to compare risk-adjusted returns across managers in specified time periods, compare returns with benchmarks and look at value at risk, including incremental VaR, for asset classes, for managers, for market risk factors, etc. NetRisk is about to introduce enhancements of slice-and-dice capabilities to give users a better view of the risk of portions of term structures. It is also introducing scenario simulation, involving user-specified shocks to market parameters.
CrystalBox’s main functions include:
access to performance information for all funds across multiple managers;
return and risk analysis across customized portfolios of investments;
traditional investment-management metrics (Sharpe ratio, tracking error, etc.) with forward-looking risk measures such as VaR;
interactive analysis of funds and accounts in the context of customized portfolios;
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analysis of the impact of a new manager, risk or asset class on the overall investment returns and risk levels. Treasurers without asset-management responsibilities will no doubt find portions of CrystalBox irrelevant to their work, but the underlying VaR implementation could be used for a general representation of corporate positions.
CYGNIFI.com
Cygnifi offers largely a spin-out of JP Morgan derivatives technology, augmented with additional or alternative models from another partner, Numerix. ASP solutions are intended to cover front-office and middle-office functions, including trade life cycle management. In addition to market risk, Cygnifi addresses counterparty exposure and collateral management. Cygnifi not only offers web-based applications directly to clients but also provides technology under a private-label or co-branding arrangement to other ASPs and financial portals. Its web-based solutions include the following.
Valuation Services provides pricing models and independent market data. In addition to valuation tools available online, Cygnifi’s valuation team engages in independent valuation of portfolios. Cygnifi’s offering is evolving, and only a part of the Morgan analytics package has so far been reproduced in the hosted application.
The product currently includes fixed-income instruments and foreign exchange, with equities and credit derivatives scheduled for inclusion in 2001. Different versions are available for portfolios of different complexity. At present VaR calculations are not included, but bucketing of Greek-letter risk measures and what-if scenario analysis are available that enable users to manipulate prices and term structures. Users of the valuation service can download information to their existing systems, save transaction and portfolio data in Excel format, or even download key information wirelessly to a personal digital assistant such as a Palm Pilot.
Collateral Management offers ASP-delivered technology for calculating basic collateral requirements, recording the structure of collateral agreements, and storing collateral valuations.
CollateralManager guides the user through the workflow of monitoring valuations and issuing collateral calls.
The Trinity provides on-line information on the legal risks associated with collateral, at various levels of detail appropriate for users ranging from expert lawyers to traders and marketers.
Counterparty Exposure Management provides simulation-based exposure calculations for counterparties over the internet. Cygnifi will be contributing this, along with its Trinity application, to CreditDimensions, a recently announced on-line community for credit risk being launched by an industry consortium that also includes Algorithmics.
Because certain basic elements of risk management are currently missing (eg, VaR), Cygnifi’s valuation offering is now perhaps most useful for corporate treasuries with limited needs, such as periodic valuation of derivatives for accounting purposes, or as a cross-check on values produced by other systems.
FinancialCad
Perfect Hedge from FinancialCad is an on-line FAS133 audit-support application. The system is designed primarily for corporate treasurers in the US, where FAS133 accounting compliance affects thousands of companies. However, it may also be useful to companies in developing countries, where the International Accounting Standard Board (IASB) Statement 39 will become the de facto standard.
Perfect Hedge provides clients with:
historical quoted and calculated assumption data to support the valuation of various underlying exposures and corresponding hedges;
definition and monitoring of hedges based on underlying transactions, cashflow information, and hedging transactions;
documentation related to hedges;
specification of reporting requirements;
measurement of hedge performance over time;
mark-to-market valuations for underlyings and derivatives on a continuing and historical basis, using daily closing data;
hedge relationships on one-to-one, one-to-many, and many-to-many levels;
hedge relationships according to risk classification and hedge type;
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key risk measures, cashflow reports, and other analytics reports. As this list suggests, the system has more complete and more convenient FAS133 reporting than that produced by more general systems that can associate hedges with underlying positions, retrieve current and historical market states, and calculate hedge effectiveness. On the other hand, though FAS133 compliance is an aspect of risk management, the product does not provide the full set of functions desirable for understanding and managing a portfolio’s risk. It may be a useful complement to existing systems or other hosted applications, particularly for corporations that do not otherwise need elaborate systems with more general functionality.
Derivatives.com (Imagine Software)
Imagine Software’s ASP incarnation, Derivatives.com, provides complete front-office, middle-office and back-office tools for a broad range of instruments, using real-time market data. Technology developed originally for equities and equity derivatives has been extended and enhanced to cover underlying instruments and derivatives in fixed income and swaps or forex, including exotic options, baskets, convertibles, and structured products.
Derivatives.com serves as a data repository, capturing and filtering data from live feeds and assembling yield curves and volatility surfaces. Users can run graphs and analytics on real-time market data for pre-trade decision support and also access historical market data for statistical studies, calculations of FAS133 hedge effectiveness, and historical VaR or stress-testing of strategies.
Derivatives.com’s Projections tool enables the end-user to perform a complete perturbation analysis on a portfolio, book, or ledger, or on an arbitrary subset of positions, shocking interest-rate, volatility, and correlation term structures as well as prices, and using hypothetical trades as well as actual trades to test hedge strategies.
The Risk Matrix tool displays time-bucketing for an extensive set of Greeks and other risk types, facilitating hedging of yield-curve and volatility risks as well as those associated with currency and equity prices, credit spreads, cashflows, and dividends. The VaR tool can use both the RiskMetrics approach and a vega component. VaR calculations by Monte Carlo simulation are capable of taking into account the appropriate rebalancing of hedges over the life of the simulation. Risk-limit monitoring can be applied to a company’s own positions or to those of a counterparty.
The valuation and risk-management analytics are comparable to those found in multi-million-dollar systems used by trading desks at top-tier financial institutions. However, Imagine Software offers the derivatives.com hosted application at $5,000 to $10,000 a month, probably affordable even for medium-size corporations.
The functional richness of the package may be overkill for many treasurers, but the more enterprising will probably learn to use it. In any case, since users are able to customize views on calculated data, firms with simpler needs for routine tasks are able to set up formats that display only the information treasurers are prepared to use.
Algorithmics
Algorithmics is primarily a technology enabler to ASPs. Its suite delivers an integrated solution package for risk management. Although it may eventually offer this technology directly as a hosted application, it is presently a toolkit for others to create applications for the management of market risk, liquidity risk, and credit risk.
The Algo suite delivers three packages that can be integrated.
Algo Market measures, manages and optimizes the market risks of investment and trading portfolios across multiple, diverse asset classes and product types.
Algo ALM measures and manages the market and liquidity risk of the balance sheet to enhance a company’s net worth.
Algo Credit provides an integrated framework for measuring and managing credit risk across the enterprise, including counterparty credit exposure, portfolio credit, and the specific risk of bonds.
Algorithmics’ offering supports over 400 types of products – including bonds, equities, commodities, foreign exchange, and a wide range of derivatives – from more than 20 different markets. The product suite supports many risk methodologies, including parametric and scenario-based VaR, stress testing, and sensitivity analysis.
Among the various end-user application services developed with the Algo suite, one of the most prominent is Credit Suisse First Boston’s (CSFB’s) PrimeWorld, which provides web-based risk analysis and management reports to CSFB clients. The end product is an on-line, end-to-end service in a single desktop application, incorporating risk analytics, research, electronic trading, order routing, settlement and clearance, and P&L monitoring. Another application is eRisk in Brazil, a joint venture with the Brazilian Pension Fund Association (Abrapp), the São Paolo Stock Exchange (Bovespa), and the Brazilian Bankers Association (Andimaa). This application enables market participants to meet regulatory reporting requirements, produce risk measurements via stress tests, and generate VaR reports. Another international application, Valor de Mercado, a joint venture between Algorithmics and Bolsa Mexicana de Valores, provides prices for all government and corporate bonds, equities and warrants sold in Mexico.
Deutsche Bank’s db RiskOffice
The db RiskOffice product is the current form of the RAROC 2020 system that made Bankers Trust’s financial risk-management software and methodology available to others. The application is a VaR implementation suitable for assets and liabilities. It covers a vast assortment of instruments in mature economies as well as developing markets. Asset classes covered include equities, currencies, debt instruments and a wide range of commodities, for which Deutsche Bank uses not only its own historical database but also BARRA data sets. Proxy mapping of private equity and real estate can also be accommodated.
Though aimed primarily at asset managers, including insurers, pension plans and hedge funds, RiskOffice can also provide valuable risk-assessment tools to corporate treasurers, in particular multinational treasuries that have activities diverse enough to benefit from its broad instrument and market span. The system is designed to take customers’ position listings and current valuations (supplied either by clients themselves or their custodial banks). It identifies cashflow patterns from CUSIP numbers, and lets the user perform analyses over the web to measure VaR, calculate factor sensitivities and examine the consequences of user-determined market scenarios.
Securities containing different types of risk are broken down into their component parts and recast as a portfolio of the 500 benchmarks – risk buckets – tracked by the software. Custom risk buckets can be created for specific types of assets, in case risks of positions are not captured adequately by the 500 predefined buckets. Drawing on historical volatilities and correlations (which can be computed using either even weighting of data points or exponential smoothing), RiskOffice then performs a Monte Carlo simulation on this modelled portfolio and displays distributional results of profit/loss change in easy-to-grasp form.
RiskOffice also provides for clients to view portfolio risk under specific assumptions about market conditions (including replication of historical shocks) and portfolio reallocations. Since it enables users to perform calculations based on portfolios that incorporate hypothetical changes, it can help treasurers test possible hedges and strategies or understand market risks inherent in potential investments.
Among RiskOffice clients is Microsoft. Max Giolitti, the software company’s treasury quantitative analyst, notes that his company spent a year examining web-based applications before subscribing to RiskOffice. Although the product complements rather than replaces software and spreadsheets previously used by Microsoft, he reports: “We are coming to rely more and more on the hosted application because of DB Riskoffice’s in-house expertise, their reliability, and their commitment to service.”
Measurisk.com
Measurisk offers hosted applications that address financial risks, FAS133 compliance, and – through a self-assessment application – what it terms consequential risks. These include operational risks but also legal risks and injury to reputation. Earnings-at-risk and value-at-risk reporting captures market risk and also credit risk, via credit spreads.
Measurisk solutions are intended to provide periodic (monthly or quarterly, though greater frequency is possible) risk evaluations that complement users’ existing dealing systems. Measurisk uploads client data using encryption technology, prescribing specific mapping constructs to enforce uniform formatting of positions. Markets covered include equity and fixed income instruments and derivatives on them (for both mature and emerging markets); mortgage-backed securities, collateralized mortgage obligations, and other asset-backed securities; credit derivatives; currencies and commodities, including energy; real estate investment trusts; funding liabilities and cashflows; and alternative investments modelled as financial-instrument proxies.
Useful for corporate treasurers is the ability to model (with Measurisk’s assistance when required) various business commitments and exposures and include these in the VaR or earnings-at-risk analysis. Such exposures might include not only accounts payable/receivable in non-functional currencies but also projected purchases/sales, leases, and so forth.
Measurisk performs instrument valuation and risk calculations using time-series data accumulated from over a dozen data vendors. Discrepancies with respect to client-provided valuations (generated either in-house or by banking counterparties) are resolved before risk calculations are undertaken. By archiving client-specified hedging relationships as well as historical valuations of clients’ positions and previous risk calculations, Measurisk supports FAS133 reporting.
The firm’s risk engine calculates VaR by Monte Carlo simulation, displaying marginal and relative VaR, tracking error, and risk-adjusted performance benchmarks. Users can perform arbitrary what-if analyses, as well as stress testing for market and liquidity risks based on historical periods of high volatility and breakdowns of correlations. The risk reporting for various levels and types of aggregation (asset class, business unit, etc.) is clear and easy to understand.
eTreasury
Offered by SunGard Treasury Systems, which acquired technology resulting from the operational merger of three leading treasury software vendors, eTreasury illustrates the continuing evolution of ASPs. The full product is available in installed form, but in the Americas SunGard has begun offering its cash-management component directly as a hosted application available by subscription. In addition to acting as an ASP itself in the Americas, SunGard supplies its technology to ASPs in London, Dublin, and Sydney, including two banks that incorporate it in websites aimed at clients. These ASPs use risk-management functionality described in eTreasury’s response to our questionnaire, rather than the current eTreasury.com cash-management product available in the Americas.
In 2001 SunGard intends to expand the functionality available for the eTreasury.com hosted application to include the full scope it claims for the eTreasury product: trading, risk management, and straight-through processing, with transfer of position and market data over the internet. Instrument coverage includes foreign exchange and commodities, a range of interest-rate instruments and equities. Functions go from pre-trade market analysis to deal capture and middle and back office, with risk understanding aided by both gamma-adjusted VaR and analysis of user-determined scenarios. In this more comprehensive form, as delivered by European and Australian ASPs and as Sungard plans to introduce it directly in 2001, the product has been designed to support accounting, and in particular FAS133 compliance. Because functionality currently available in the Americas is limited to cash management, we did not request a demonstration of the product.
Vendor responses to the survey
We present the vendor responses to our survey questions concerning the scope, purpose, and strengths of each offering at www.euromoney.com, as well as more detailed questions about specific functionality. We did not have the opportunity to verify all responses by active testing. It is possible that items of functionality, claimed by certain vendors that provide both hosted applications and installed software, may be available in the installed form but have not yet been incorporated into the hosted application, or may be available (as in the case of eTreasury) through applications provided by bank ASPs.
Issues and applications
With powerful tools now available as hosted applications – either as self-contained comprehensive solutions or as more specialized extensions of existing systems that analyze risks of uploaded positions – the days of licensed software installations may be numbered. Some clients see a clear advantage of hosted applications in the ease with which vendors can modify them without having to install and test new releases at each client site.
As Microsoft’s Giolitti observes, the shorter process of change facilitates “up-to-date modelling of new instruments, without pain for us”. In addition to the greater risk control made possible by faster vendor response to market innovations, Giolitti claims savings of “hundreds of thousands of dollars per year” from use of web-based tools over solutions that involve “the need to design costly in-house solutions.”
Others see advantages in installed applications. Larry Tabb, director of securities and investment practices with the Tower Group, points to the reluctance of investment managers to entrust portfolio information to another party, and believes that vendors will inevitably be less responsive than internal software development and maintenance staff. In this regard he questions the responsiveness of ASPs compared with vendors of installed solutions. “Will a vendor be as responsive,” he wonders, “to a customer that only pays 5% per trade [compared with] someone that is going to pay $5 million for a software licensing deal?” Will hosted applications eventually supplant licensed, installed software? “This is the trend,” he nevertheless admits, “however, it will not happen overnight.”
Some believe that customization requirements argue for existing clients sticking with installed solutions. According to Deutsche Bank’s Michelle McCarthy, few clients are abandoning installed software for hosted applications. “I think hosted applications are of interest to those who have not yet bought licensed software,” she says. Algorithmics vice president Michael Zerbs takes a similar position. He expects clients to combine their current installed solutions with the convenience of web-browser interfaces offered by hosted applications. “The real trend,” he says “is for the large clients to adapt their licensed risk-management software installation into hosted applications, and work with the vendors or third parties to engineer HTML-based application interfaces.”
All vendors reckon that the economics of hosted solutions will expand their market. Murray Nash, managing director in charge of NetRisk’s CrystalBox product, explains: “First, the efficiency gains from ASP-type offerings will make available to users functionality which was previously out of reach, either because it was too costly or imposed too much of a burden on the client’s infrastructure. Second, the connectivity offered by the internet creates new opportunities to put risk information in the hands of a new set of users. For example, CrystalBox exploits connectivity to enable pension plans to measure risk across multiple third-party money managers. Until recently this simply was not feasible. Third, hosted systems with flexible interfaces to source systems provide users with the opportunity to benchmark the output from their primary system against alternative systems and methodologies. Quantifying differences and understanding the reasons for the variation across models is a very high value added service to both the risk management and business functions.”
In their assessment of the evolving market, vendors distinguish between the larger institutions that live by daily risk information driven by real-time market data, and the lesser demands of firms that examine risk information less frequently. Deutsche Bank’s McCarthy believes that for the latter, web solutions will indeed supplant the traditional installed software. Algorithmic’s Zerbs sees the same potential: “Wherever risk management is a requirement or constraint but not a [core] competency, there is potential for a web-based solution to replace current structures.”
All vendors see some tendency toward a generational split, with older risk managers remaining more comfortable with installed solutions and younger personnel favouring hosted applications. As David Glassco, FinancialCad’s CEO, puts it: “Generation Xers are very much into the web, and for those people that are working in the treasuries and trading rooms it is the way of life.”
Gaining widespread adoption of hosted risk-management applications illustrates the general challenge of transforming products that have appealed to early adopters – here sophisticated traders and risk-managers at the largest institutions – into products that compete for a mainstream market on the basis of ease of use and lower cost.
