I recently attended a PRMIA event hosted in London that explored how to navigate through the vast uncertainty created by Brexit. Attendees listened in on lively panel dialogue offering diverse perspectives on how financial institutions and technology providers can best adapt. This included a discussion on the economic and legal implications, as well as analytics and risk management issues created by Brexit.
Indeed Britain’s landmark decision to leave the EU has left a ton of unanswered questions. Initially the markets reacted quickly to the decision, but mostly bounced back. During the event, some argued that the effects of regulations from the EU are yet to be seen and felt. However a legal expert was assertive in saying that they will be seriously felt if the final result of the Brexit negotiations do not allow for UK-based institutions to sell products and services to EU countries.
Attendees also had the opportunity to hear from industry expert and FINCAD advisor, Erik Vynckier, who discussed relevant risk and quantitative modeling considerations, including how to adapt to Brexit and other similar uncertainty in a negative rate and multi-currency environment.
In the presentation, Erik explained that many investment managers today are searching for new ways of better understanding, and ultimately adapting to the tumultuous market environment. To accomplish this goal, firms are specifically looking at analyzing potential investments and their outcomes. They are doing this by modelling their data into market scenarios with the aim of ensuring that their portfolios can effectively adapt.
Of key importance today is having models that can adapt to complexity, like negative rates scenarios. This can help ensure effective pricing and risk analysis of portfolios for fixed income securities and derivatives. One of the modeling methodologies Erik reviewed in his presentation was SABR, as the model is able to accurately support negative interest rate scenarios with free lower boundaries. The SABR model has emerged as the market standard approach to modelling swaptions in particular where the context of negative rates has been felt most acutely.
A critical take away from the PRMIA event is that firms that wish to flourish in a volatile, Post-Brexit market, will need to harness an effective scenario and risk framework. This type of framework should be capable of incorporating different risk types and adapting to custom scenarios. It should be able to look at the impact of both what has happened historically, and what is likely to happen in the future. It should also be flexible enough to allow firms to quickly change their modelling approaches at will.
The reality is that firms that are ready and able to meet the demands of a changing business environment will be better positioned to remain competitive in the marketplace. Essentially, the best way to navigate through the uncharted territory of Brexit will be for firms to arm themselves with systems that are nimble and flexible, thus making it easier to adapt to change.
Your technology, for instance, should give you the ability to swap models both in and out of your valuation and risk framework without downtime or coding effort. This will give you greater control in adopting new modeling approaches, which should be driven by business need and not constrained by inflexible technology.
For more information on preparing for the unexpected, check out a video interview of John Hull, PhD, and Alan, White, PhD.