Building better Risk Management Systems using Technology as a backbone – Interview of Samir Jayaswal, SVP & Head of Operations, Prism Cybersoftadmin
Building better Risk Management Systems using Technology as a backbone – Interview of Samir Jayaswal, SVP & Head of Operations, Prism Cybersoft
Why is risk management so important today?
It is no mystery that the recent financial crisis happened because of lack of sound industry wide risk management and mitigation policies. With the death of so many old institutions and extremely precarious times faced by institutions that survived, it is extremely important for markets to have more holistic, industry wide risk management policies in place which all institutions and participants believe in.
There comes time like these where it is not a question of how many millions lost but the question becomes that of survival. With so much of terrorism, political instability, developed nation defaulting, Chinese shocks etc, we will see periods of continuous volatility. In fact, someone had noted that volatility is the new normal with some periods of calm in between. This is a new world order and people and institutions must learn how to live with it. Thriving in it will need a different competence altogether. In my mind, emphasis on risk was never as strong as it is today and with every passing day it will only get stronger and it is as important a function as banking, trading or settlement.
Does risk also play a developmental role?
There are several aspects to measuring and managing risk. Institutions want to know at all points of time how much risk they are facing so that they can be adequately capitalized. Ability to bear market risk is just not sufficient. Earlier a lot of emphasis was given to credit risk but now with better technology, risk can be better modeled and hence to a very large extent market risk and operations risk is also being calculated accurately and are being provisioned for.
Post 2008, liquidity risk is being seriously measured. Institutions want to be much more liquid than earlier even at a cost. A liquid and better capitalized marketplace is good for all because it lends tremendous confidence amongst participants leading to overall development and growth for the market as a whole.
There is also a fraud angle to it?
The business of financial industry is all about money. Serious flow of money happens within seconds. Institutions and processes are built with extreme care to make sure activities like trading, clearing and settlement etc happen in a risk free environment. Markets free of risk are very important if it needs to attract serious participants and liquidity. It is also easy to understand that industries like finance attract a lot of rogue elements looking to circumvent the system in search of quick money. Depending on the markets they operate in, they design specific schemes to defraud people and systems and make money out of it. Actively implementing technology to increase vigilance, measure and manage risk is therefore important to prevent such losses.
Who should be responsible for risk management?
Risk management culture in any organization should be all pervasive. The culture must come top down but even the junior most employee must be made aware on how they must be vigilant. Proper training must be provided at all levels of the organization to identify, report and mitigate risks actively. Finally, there should be an appointed Chief Risk Officer where the buck must stop. Until some years ago this position didn’t exist. However with increased focus on risks, a lot of organizations now have this position.
What is the cost of implementing risk management systems in financial markets?
Contrary to popular beliefs, a 2013 RIMS survey concluded that the cost of managing risk is lesser in finance industry as compared to any other industry. This is because operations in finance industry is not hazardous and nor does it require huge investment in plant, machinery etc. It is hence very easy to put good risk management systems in place and the return on investment in this space is also very high.
What is some key risk management challenges technology is trying to solve currently?
There are several areas with renewed impetus after the global financial crisis in 2008. Areas like Market Risk Management, liquidity measurement and management, settlement risk management for OTC derivatives etc are on the forefront. On the listed instrument side, although the goal of T+1 has been deferred, every step of transaction is continuously improved and made risk free. Correct way of managing collaterals in such a volatile environment is also being reviewed. Finally a lot of systemic issues are becoming important and taking up too much attention. Technology is helping modeling of such integrated risks.
Talking of brokerage space, how can Know Your Client requirement be strengthened using technology?
When there is a market upsurge, sales team gets in hundreds of customers each day. When an institution has millions of clients overall, it becomes very difficult to do credit assessment of each individual client. It is impossible to ascertain the quality of each client. Technology helps in basic filtering at this stage. There was a case where in order to meet targets, a sales person used to send dubious client details with his own mobile number and e-mail ids. A basic check on duplicate mobile number and e-mail id spilt the beans. Apart from employee introduced dubious clients, financial institutions continuously face adverse selection. This means they get flooded with account opening and loan requests from thousands of people who the institution wishes to avoid. Technology helps in separating wheat from chaff.
Technology also helps the KYC team monitor basic things like income and financial profile of the customer and puts his transactions in correct perspective. This helps the compliance team understand if there are any PMLA violations.
It is also very important to have technology that can do real time assessment of the risks these clients are making the market face because of their own trading activities at all points of time. We also need to measure in real time the value of collaterals held by their brokerages or central counterparty like the clearing corporation on their behalf.
What are some other safeguards that need to be taken?
While talking of collateral, in these days of high volatility in stock prices, technology can be used to measure concentration risk of collaterals. There has been up to 70-80% erosion of stock prices in some company’s stock values in a couple of days and it could be very dangerous if the trading activity on the same stock which is also submitted as collateral.
In the exchange space how much has market evolved in terms of risk?
Market has become a lot more aware of risk and matured. Both buy side and sell side institutions have covered every part of the transaction value chain to ensure they are not exposed to any obvious risk. There was a case that was encountered when futures and options trading had just started. Someone opened two accounts with different brokers. At that time KYC practices were not stringent. Through one of the brokers this client put a buy order for deep in the money call option with a bid of few paise. Since what he wanted was an option with too much intrinsic value, no one was selling to him. He then called the second broker and put a sell order himself against his own buy order put through the first broker. This was an untested scenario and there was no risk check. The orders matched. Later that evening, he exercised the option from where he bought and fled from the second broker. Brokerage system and exchanges have tightened their systems considerably after that. However continuous improvements must take place.
There is a lot of emphasis on Anti Money Laundering. How is technology used to detect it?
There are a lot of sophisticated mechanisms used by money launderers and technology is continuously updated to detect such transactions which are suspicious. Banks regularly comb accounts where there are unexplained debits and credits. Depository participants keep a tab of off market transfers where the amount is not consistent with the financial profile of the customer. Insurance firms track any third party transfer requests. Securities market is very lucrative for money launderers because apart from helping them launder money, securities market also allows them to make more money by making investments. Software products regularly check for clients providing misleading information to intermediaries while opening accounts, clients making many small cash deposits and buying securities when the amount becomes large or clients using brokerage accounts to hold funds for long term and similarly using broker’s pool accounts or broker’s beneficiary’s account to hold shares for long term. It also looks for transactions where one party is seen to be deliberately taking loss thereby transferring money to another etc.