Product Control: Improving Precision in Volatile Markets

ActiveViam |
May 18, 2020

COVID-19’s devastating impact on human health and its subsequent cascading effect on the global economy and job market will reverberate for years to come.

Keeping the global population safe and healthy remains a top priority for governments across the world. For financial institutions, a heightened awareness of risk management is fundamental to maintaining the health of the firm.

Product control is a cornerstone of market risk management, requiring  the daily precise calculation and reconciliation of trade and position valuations. The function grew in importance after the global financial crisis of 2008 exposed weak controls at some banks. However, systems to strengthen the function have lagged as compliance with waves of new regulations took priority.

Now, tipping their hat to current events, global regulators have eased some requirements and pushed out the compliance date for others. The goal is to free up banks to manage capital and trading operations amid the turmoil. This also gives institutions time to integrate new scenarios such as the current one into their future risk management plans.

Firms that needed to comply with uncleared margin rules by September have an additional year to do so and the next phase of participants were granted two years. Basel III requirements overhauling the market risk framework, including the Fundamental Review of the Trading Book, have been pushed out another year to 2023.

This hardly means product control gets a pass.

Regulators created a “best practices” framework – but it does not yet apply. Product control teams would want to seek out best-in-class technology to do their job efficiently irrespective of regulatory guidance. Now is as good a time as any to “kick the tires” on outdated processes.

Volatility Amps Up Pressure

Negative rates and negative oil prices have pushed traders and investors into equities even while stock prices were whipsawed in line with sharp moves in the S&P 500.

The Chicago Board Options Exchange VIX index, a 30-day measure of implied volatility on S&P 500 index options provides a barometer of market risk. The VIX hit its highest level since inception on March 16, 2020, the Monday after the United States closed its borders to European air travel to curb the spread of the coronavirus, surpassing the peak hit during the 2008 financial crisis. The VIX has since receded.

Sharp swings in volatility make it harder to calculate an accurate mark-to-market price and measure portfolio risk, which filters up to the balance sheet. Product controllers need to liaise with traders in the front office on a daily basis to reconcile flash PnL with actual PnL. A T+1 settlement period for options does not leave much time or wiggle room for unexplained material profit and loss. This makes bridging flash and actual PnL more of a challenge, magnified by the impacts of the current crisis.

Individual trading desks as well as risk and finance teams each have their own systems, further complicating the task. Multiple, fragmented solutions where much of the data (market data, reference data, etc.) needed to calculate precise PnL remains unsynchronized as it passes from one system to another increases the risk of mistakes.

Product control needs to be in all places at once with front office, finance and risk more closely aligned than ever before. A single, flexible system that serves as a focal point for all those involved in the process offers a level of immediate comfort and control as well as increased efficiency.

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