Rethinking risk

Publication date: 9 March 2012
Author: Frances Maguire, Columnist, FX-MM

Tagged with: Corporate FX Risk, Frances Maguire, FX trading, Gilmore Bray, Gold-i, Misys, Paul Bramwell, Risk Management, SunGard, Tom Higgins, Treasury

The management of foreign exchange risk is driving a need for multi-asset trading and positionkeeping risk management platforms to eliminate as much post-trade operational risk as possible. Frances Maguire looks at the solutions that are helping firms manage FX risk.

Increased volatility in the FX markets, particularly in the Eurozone, has been driving both brokers and the buy-side alike to find smarter ways to manage the impact of FX risk across all asset classes. Several differing strategies are emerging as a result of this. This is leading to increased automation to eliminate operational risk, post-trade, as well as the increased use of FX options and the inclusion of FX trading in multiasset class trading platforms.

These trends also include the move to more centralised treasury technology to gain better visibility of positions in order to manage risk, streamlining corporate-to-bank connectivity, which may include managed SWIFT connectivity and eBAM, as well as using hosted private cloud environments to remove the burden of IT maintenance and enable treasury departments to focus on liquidity management.

According to global application software and services provider, Misys, the rise in the volume of FX options is part of a broader trend of corporations updating their hedging strategies using FX options to hedge that risk owing to the uncertainty in the Eurozone and global economy. FX options are now increasingly the strategy of choice as they provide much more flexibility and protection against the volatility.

Using the Misys electronic Confirmation Matching Service (CMS) solution further removes post-trade operational risk.

An analysis of client activity matched through Misys CMS from September 2011 compared to September 2010 showed there had been an increase in matched trades of over 100%, indicating a rapid increase in the use of FX options by its corporate and fund management clients.

Combined with a 25% increase in active client sites, Misys says the rise demonstrates the heightened volatility in international currency markets, and the increasing need for corporations to review their hedging strategies in times of increasing uncertainty and volatility in the FX markets.

Gilmore Bray, Global Managed Services Director at Misys says: “The growth in post-trade processing activity also comes at a time of increased active clients, which is up 25% showing a real move towards FX options, and an acknowledgement by our clients that Misys CMS is truly a multi-asset class service. It’s a challenging time for our clients, and simplifying the processing of complex trades through our solution can help them focus more on their strategies, and not have the worry and risk of manual post-trade processes.”

He adds that Misys began to see an increase in the usage of options in late 2008/9 and he puts this down to the technology that became available, and the fact an increasing number of banks were able to send Swift MT305 (put and call options) and MT306 (exotic options) messages for confirmations directly to CMS.

Furthermore, he says that corporations are no longer just doing spot, forwards and swaps, but have added options to reduce the transactional and market risk where they are hedging the purchases of materials or product sales. “So the growth is also due to a growing sophistication by corporate treasurers in reducing risk and certainly put and call options are an easy starting point.”

Bray says that the magnitude of the recent volatility risk is driving the rise in the vanilla put and call options as corporations look for other means to reduce their risk. The growth has come from a mixture of new and existing customers, which are switching from forward trades into options.

Many of Misys’s clients come to use CMS as an entry to options post trade processing, and, Gilmore adds, through an ASP or software-as-a-service capability, CMS can handle all of a corporation’s confirmations through a single window. He says: “A number of our clients are using CMS on a black-box basis – they are uploading the trades from their treasury work stations, scheduling a download of a report to update their treasury work station.”

Bray believes the surge of FX options usage has come from an increase in volatility. It is also coming from a combination of a growing sophistication and a willingness to look at other types of instruments to hedge FX risk, as well as regulatory pressures on audit, compliance and being able to show there is a complete audit trail to confirm trades.

Paul Bramwell, senior vice president, treasury solutions at SunGard’s AvantGard, agrees that corporates are discovering new ways to harness technology to increase their visibility to cash and to better manage the risks that have become more prevalent, such as FX, credit, interest rate and commodity risk.

As well as finding better ways to work with their bank and trading partners by improving transparency to the financial supply chain and streamlining messaging and communications, they are also increasing deployment of treasury technology in private cloud environments, helping them realise greater efficiencies and reduce IT costs.

SunGard, which provides its AvantGard Treasury and liquidity management solutions to corporates, has identified several trends that are influencing how corporate CFO’s, treasurers and other finance executives operate their treasury departments and manage liquidity.

Bramwell says that corporates are striving to attain a holistic view of risk and are increasingly modelling multiple risk types such as FX, credit, market, interest rate and commodity. To this end, they are seeking to gain enterprise-wide views of FX and interest rate risk positions with real time debt and investment reporting.

He believes that the recent refocus on FX risk management has come from the need to examine the potential impact of FX hedging on business. This focus, he says, has most impacted the US dollar-denominated market and has also been fuelled by the global financial crisis and the current euro instability. “There is a realisation, with so many companies making earnings calls, that business gains are being heavily influenced by FX gains and losses,” he says.

Bramwell adds that the tools to manage FX risk have not only become better, but much more affordable, enabling corporates to hook up all subsidiaries to a single corporate treasury platform, across transactional currency risk and balance sheet exposure risk, and allowing natural offsets through aggregation. He says: “Once all this data is in one location, there are tools to be able to analyse it. This can be as comprehensive as running value-at-risk, or Monte Carlo simulations across an entire portfolio of assets, currencies and interest rates, or it could be as mundane as simply looking at a forecast of currency receipts and payments or looking to hedge forward or spot contracts, and layering scenarios on top of this. The technology gives the ability to perform an enormous amount of calculations across a very comprehensive data set, making it much easier to model complex types of transactions across multiple scenarios.”

He adds that treasurers are looking to improve working capital through improved credit risk analysis and collections automation strategies, resulting in reduced borrowing margins, by centralising treasury operations or streamlining and consolidating their payment flows. In order to continue to improve operational efficiency, Bramwell believes there will be a continued movement towards outsourcing transactional treasury functions or deploying their treasury technology in cloud hosted environments.

He says: “More corporations are turning to consolidated technology hubs for multi-bank conn – ectivity, including embedded services such as eBAM and managed connectivity to the SWIFT network.”

On the retail side too, greater sophistication is prompting a review of FX risk management on a broad scale. Tom Higgins, CEO of Gold-i, a company that specialises in retail FX and CFD integration with MetaTrader, says that the need for improved FX risk management is being driven by a more sophisticated end-user. He says: “End clients are getting better at trading. They are buying more sophisticated algorithms, therefore doing more automated trading and making more money, which means brokers have to work harder to manage and offset that risk.”

A risk management bolt-on allows brokers to see current open positions in real-time, and realised and unrealised P&L from previous trades, for both the house and the client side. This ensures that the broker can see what net risk it is carrying and the value, in real-time.

Most inter-dealer brokers will have multiple trading systems and for this reason Higgins says they need one holistic view of their position in real-time. He says: “Without some form of central feed into the back office, they can’t do this, and the Gold-i Gate Link has been very popular. We have added more features, such as cash management visibility. By automating this we reduce the risk of inconsistencies of data between cash and the core trading systems.”

Today, brokers rely on their dealers to manage their exposure but going forward Higgins believes they are not going to be able to rely on this anymore. “Brokers will need more business intelligence tools, analysing the client data, statistically, to see the trends and properly manage client risk. Covering client risk is done quite arbitrarily at the moment and this needs to be backed up with automated systems to do statistical analysis so they have a much clearer picture of client trading patterns and behaviour.”

Gold-i is currently developing a smart routing system to enable the brokers to do this. This goes further than simply aggregating trades. Higgins says: “By allowing brokers to choose where to route trades based on risk rules, Gold-i’s smart routing product will analyse net positions, enabling brokers to have much greater control over risk. The product will combine risk analysis and automation. There is so much data that it is impossible for brokers to work this out without the intelligence tools to do this for them.”

Last month, Vista Equity Partners completed its acquisition of Thomson Reuters Trade and Risk Management business, and the newly renamed company, Turaz, unveiled the latest version Kondor+.

A new flexible architecture has dramatically improved the product’s openness and flexibility towards integrating third-party pricing and analytics, market data and other extended market capabilities. It introduces a highly scalable architecture for real-time reporting and simulation. It brings all the relevant information traders need for critical business decisions into one highly intuitive and flexible view.

Joerg Heidtmann, Global Head of Innovation at Turaz, says that feedback from clients using Kondor+ for FX and money markets indicates that the FX department of a bank is turning into a service provider for the bank and its customers, providing specialist intelligence tools and structured products for hedging and credit risk management as well as liquidity and funding.

He says: “Kondor+ needs to reflect this trend to provide services to any areas of the bank which conduct trade capture, position keeping and reporting. It can also provide a broader range of more complex and customised services for other departments outside the treasury, Risk department – CVA calculation, hedging or curve.”

Heidtmann divides the challenges for managing FX risk into two camps. Firstly technical – providing complete integration of execution values and fast connectivity to liquidity pools. Secondly the intellectual challenges: ensuring market demands are met by offering tailor-made hedging strategies, combining different asset classes or hedging multi-leg FX and liquidity exposure combined.

He also adds that treasuries now, more than ever, want systems which ‘are alive’ to the risks which arise as a result of trading across all asset classes, (including correlation and credit). Allowing treasurers to quickly identify, quantify and manage these risks. With the new upgrade of Kondor+, these services are now available for different departments across the bank, and their customers.

The technology available for FX risk management is enabling better aggregation and more sophisticated analytical capabilities, but SunGard’s Bramwell believes that the management of FX risk is not an area that is well-suited to third-party outsourcing and is unlikely to be outsourced in the future due to the P&L consequences of error.

Instead, Heidtmann believes the next big challenge is the proper support of algorithmic trading while maintaining real time processing for deal import and position keeping. He says: “The main driver we are seeing for the management of FX risk is the use of algorithmic trading. The biggest challenge for banks now is to embrace algorithmic trading and to monitor it efficiently – they need to be able to manage it in real-time, tick-by-tick, with fast response times built into their systems. Going forward, real-time infor – mation is the key to success for operations in FX and money markets.”