A complex tangle of embedded components
Over the past three decades, Front Office Risk Management (FORM) has developed in a piecemeal way. As a result of historical business drivers and the varying needs of teams focused on different products within banks, FORM systems were created for individual business silos, products and trading desks. Typically, different risk components and systems were entwined and embedded within trading systems and transaction processing platforms, and ran on different analytics, trade capture and data management technology. As a result, many banks now have multiple, varied and overlapping FORM systems.
Increasingly, however, FORM systems are emerging as a fully fledged risk solution category, rather than remaining as embedded components inside trading systems or transactional platforms (although those components still exist). For many institutions FORM, along with the frontoffice operating environment, has fundamentally changed following the global financial crisis of 2008. Banks are now dealing with a wider environment of systemically reduced profitability in which cluttered and inefficient operating models are no longer sustainable, and there are strong cost pressures for them to simplify their houses.
Equally, a more stringent and prescriptive regulatory environment is having significant direct and indirect impacts on front-office risk technology. Because of regulators’ intense scrutiny of banks’ capital management, the front office is continuously and far more acutely aware of its capital usage (and cost), and this is having a fundamental impact on the way the systems it uses are evolving. The imperative for risk-adjusted pricing means that traditional trading systems are struggling to cope with the growing importance of and demand for Valuation Adjustment (xVA) systems at scale. Meanwhile, regulations such as the Fundamental Review of the Trading Book (FRTB) will have profound implications for frontoffice risk systems.
As a result of these direct and indirect regulatory pressures, several factors are changing the frontoffice risk technology landscape:
- The scale and complexity involved in data management.
- Requirements for more computational power.
- The imperative for integration and consistency with middle-office risk systems.
Evolving to survive
As banks recognize the need for change, FORM is slowly but steadily evolving. Banks can no longer put off upgrades to systems that were built for a different era, and consensus around the need for a flexible, cross-asset, externalized front-office risk system has emerged.
Over the past few years, most Tier 1 and Tier 2 banks have started working toward the difficult goal of
- and externalizing
their risk systems, extracting them from trading and transaction processing platforms (if that’s where they existed). These efforts are complicated by the nature of FORM – specifically that it cuts across several functional areas.
Vendors, meanwhile, are struggling with the challenges of meeting the often contradictory nature of front-office demands (such as the need for flexibility vs. scalability). As the frontoffice risk landscape shifts under the weight of all these demand-side changes, many leading vendors have been slow to adapt to the significant competitive challenges. Not only are they dealing with competition from new market entrants with different business models, in many instances they are also playing catch-up with more innovative Tier 1 banks. What’s more, the willingness to experiment and innovate with front-office risk systems is now filtering down to Tier 2s and smaller institutions across the board. Chartis is seeing an increase in ‘build and buy’ hybrid solutions that leverage open-source and open-HPC2 infrastructure.
The rapid development of new technologies is radically altering the dynamics of the market, following several developments:
- A wave of new, more focused tools.
- Platforms that leverage popular computational paradigms.
- Software as a Service (SaaS) risk systems.
More often than not, incumbent vendors are failing to harness the opportunities that these technologies and new open-source languages bring, increasing the risk that they could become irrelevant within the FORM sector. Chartis contends that, as the market develops, the future landscape will be dominated by a combination of agile new entrants and existing players that can successfully transform their current offerings. Vendors have many different strategies in evidence, but the evolution required for them to survive and flourish has only just begun.
With that in mind, we have outlined several recommendations for vendors seeking to stay relevant in the new front-office risk environment:
- Above all, focus on an open, flexible environment.
- Create consistent risk data and risk factor frameworks.
- Develop highly standardized interfaces.
- Develop matrices and arrays as ‘first-class constructs’.
- Embrace open-source languages and ecosystems.
- Consider options such as partnerships and acquisitions to acquire the requisite new skills and technology capabilities in a relatively short period of time.