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Perspectives on Risk Management, Real-Time Valuation and Scenario Analysis for Hedge Funds

EZESOFT client conference

FINCAD’s Director of Analytics, Dr. Tony Webb, shared a few thoughts on risk as a panel speaker at this year’s EZESOFT client conference. The panel discussion focused on OTC derivatives risk from a regulatory, market, and valuation perspective. Below are some key points from the session from a buy-side perspective.

Due to regulation many funds have been increasingly concerned with risk process implementation via Form PF, UCITs, and AIFMD. Even though this started out as a regulatory initiative, firms have recognized the benefit of utilizing risk processes not only for compliance, but also to drive competitive advantage. As a result, we are seeing growing adoption of risk management practices beyond regulatory requirements. These practices have included more developed usage of scenario analysis, stress-testing, and statistical measures such as Value at Risk.

The panel spent significant time discussing OIS curve building in the context of collateralized derivative valuation for OTC and centrally cleared markets. The move to OIS discounting has resulted in a broad evaluation of financial analytics - including simulation of Libor-OIS basis across different tenors and different currencies. These considerations all need to be incorporated far more rigorously for firms active in these instruments.

A key issue mentioned was the challenge in modeling risk for non-cleared derivatives when margining does not completely capture counter party risk. Accurately modeling CSA agreements to reflect counterparty risk remains a challenging issue for buy-side firms.  Other aspects from an operational standpoint include satisfying potential future margin calls and capturing a comprehensive picture of liquidity risk.

Panelists also discussed the evolution of independent risk and the evolving role of the hedge fund and asset manager CRO. This has been most successful at firms that build a risk culture at their firm built on systems, structure, and processes.  One lesson learned from the most successful firms around risk implementation has been solutions which are flexible and nimble in adapting to regulatory change. Also, systems need to be utilized as high-performance decision making tools and not simply for regulatory compliance.

Attendees also heard how risk can be more integrated when looking at numerous complementary risk measures including:

  • Scenario analysis to create finite numbers of scenarios and evaluate the impact of each scenario
  • Stress-testing to determine when certain events might not be captured by running risk calculations (like VaR) from historical data, VaR & expected shortfall to evaluate impact over time horizons whereas risk sensitivity measures such as greeks, DV01, are key for intra-day decision making such as adjusting hedges. 
  • Overall, this session emphasized the need to think about risk technology in a new way. Risk management can be adopted and leveraged in ways firms haven't traditionally utilized it. These ways may include implementing real-time and on-demand risk to replace overnight batches, or the ability to change risk frameworks on the fly to nimbly adapt to regulation.

About the author

Matthew Streeter CFA's picture

Matthew Streeter CFA

Capital Markets Strategist, FINCAD

Matthew Streeter, Capital Markets Strategist at FINCAD, has expertise in derivatives trading, structuring & pricing models as well as a background in operations, pension fund analysis, hedging strategies and PnL / performance reporting. He has held positions at JP Morgan, Société Generale, Wachovia Capital Markets, Bank of America and Deutsche Bank.

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