The painful economic shocks and their lingering repercussions in the past three years have made the truth inescapably clear: Financial markets have lacked the speed and agility they need to assess their various risk exposures to catastrophic changes – so-called “black swan” events. The International Monetary Fund (IMF) estimates that total bank write-downs for the period could exceed a shocking $2 trillion.
As the past few years have shown us, many firms still can’t complete the critical stress-testing scenarios they need to revise when market conditions swing dramatically. They can’t perform the pre-trade analytics to assess projected risk/reward – before the opportunity disappears. And they can’t recalculate fund valuations and strategies on the fly. The firm gets relegated to a second-tier player, unable to keep pace with the speed and volatility of today’s markets, and unable to seize short-lived opportunities to compete more effectively.
These shortcomings create major difficulties, including:
Greater losses – Without proactive stress testing, you can’t plan for the impact of mark-to-market changes in the value of financial instruments you hold.
Excessive risk-taking – Without firmwide stress-testing and scenario analyses, market shocks can push your firm’s positions into greater concentrations and outside target risk levels.
Liquidity constraints – Unplanned reductions in instruments and position values (due to ineffective stress testing) can make funding prohibitively expensive or unobtainable during market shocks.
Increased counterparty risks – Firms need to prepare for the impact of market shocks on the firm’s counterparties that could create liquidity issues for your own firm. Firms merely absorb losses rather than hedge them.
Inadequate capital positions – Without fully understanding capital requirements, the firm cannot create appropriate capital buffers during good years to sustain itself during stressed economic times. That translates into regulatory violations and unnecessary (and, often, unseen) risk.
The fact is, sophisticated models and technology have fundamentally transformed how financial services markets operate. In bygone days, market risk was a day-end event. In a 24/7 trading world, portfolio diversification no longer protects against catastrophic market failures. Assets become highly correlated and markets move downward in tandem.
Today, firms must assess market risk in time frames approaching the microsecond. A trader has less than a second to know what a proposed trade will do to the risk profile of the portfolio. Just 25 years ago, fund managers boasted of computer systems that could handle 1 million trades a minute.
The new standard is 1 million trades per second. It’s an arms race – and firms need extremely low-latency trading to quickly assess aggregated levels of exposure across counterparties, markets and instrument types using stress-testing scenarios, pre-trade analytics, funding strategies and valuations. Without the ability to handle both business-as-usual and extreme cases when assessing risk, the firm faces a soon-to-be insurmountable competitive obstacle and possible severe trading lossses.
Applying high-performance computing to risk management
Calculation-intensive processes. Split-second windows. High-stakes decisions. These requirements characterize the types of problems that high performance computing architectures are inherently designed to address. Through a close partnership with HP, SAS has developed a high-performance risk solution that combines methodology with technology to immediately perform valuations of large and complex portfolios, facilitate intraday decision making and analyze changing market scenarios. Benefits include:
- Immediate analysis– Using the massive in-memory capabilities of HP’s BladeSystem and ProLiant server platforms, SAS dramatically accelerates traditional analytics and decision making by capitalizing on the latest speed improvements in multicore CPUs, decreasing costs for memory, and patent-pending SAS software architecture and algorithms. As a result, companies can calculate portfolio and valuation information in minutes and hold that information in-memory so that queries and analyses can be delivered in real time.
- Immediate access– SAS exponentially accelerates calculation time for determining cash flows, margin requirements and the funding impact of pending trades – drawing on all relevant internal and external data sets such as econometrics and ratings. Again, the results remain in-memory for speed-of-thought analysis.
- Immediate results – The HP and SAS combination supports very large risk-factor sets and multiple market states in an on-demand fashion. Firms can turn around portfolio analytics, add risk factors and validate assumptions for any number of metrics. That lets firms perform dynamic stress testing and make information-driven capital-optimization decisions – in minutes, not days.
The global economy is based on $100 trillion of investable assets, a figure that is expected to be five times as large in the next 15 years. What’s more, the number and complexity of vehicles to manage and invest that capital will become increasingly intricate and broad – from private equity to statistically driven arbitrage across multiple product lines – all to create a more efficient market that spreads wealth and prosperity to every corner of the earth. But it also means that the stakes are higher and the challenges are greater than ever before.
The requirements to comply with increased regulation – while still adding value, delivering a more complete view of a firm’s risk/reward profile to meet stakeholder needs and supporting the decision-making process – present a significant challenge to all firms. Efficiency and transparency are now nonnegotiable.
The risks are so critical that properly managing them and controlling them is the new imperative for financial services. We will see leaders move ahead with new infrastructure that not only offers the ability to manage change but also better understand and then respond to micro and macro financial markets shocks. Firms will have a more complete view of the risks that underpin the senior management’s strategic appetite for operational risk across business units.
Collaboration and a firmwide risk management culture must be supported by a common framework powered by high-performance computing architectures. This improves the position of financial services firms to respond to the stiff challenges that await, learn the lessons of predecessors, and avoid these and other pitfalls in the future.