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The old gray mare ain’t what she used to be: risk management today

June 13, 2011

Risk management was the topic of the day at the NICSA East Coast Regional Meeting, held Friday, June 3rd in New York City. Our keynote speakers provided insights on the latest news and trends:

Do you hear that whistle blowing? András Teleki, Partner at K&L Gates, kicked the conference off with a discussion of the new whistleblower rules, which the SEC adopted in April as they were required to do by the Dodd-Frank legislation. The new regulations give individuals a substantial financial incentive — in the form of a share of any monetary sanctions exceeding $1 million –to blow the whistle at their firms.

Companies are concerned that the potential rewards are so large that whistleblowers will be encouraged to go to the SEC first, before expressing their concerns to their compliance department. András quipped that “it won’t be long before you see the late-night TV ads” encouraging whistleblowers to come forward from law firms hoping to get a share of the prize by representing them. [Author’s note: These firms are already advertising on the web. Do a Google search for “whistleblower.”]

Q: How can firms protect themselves against the risk?

A: By making their compliance programs very strong and diligently documenting the follow up to any concerns raised. And remember that anyone can be a Dodd-Frank whistleblower — a competitor, a consultant, an investor, an ex-employee or even the ex-spouse of a current staff member.

Look to the data. Jonathan Sokobin, Acting Director of the Division of Risk, Strategy, and Financial Innovation at the SEC, talked about how the Commission is relying more on quantitative analysis to identify and protect against risk. Two examples:

  • Derivatives regulation. RiskFin, as the division is informally known, is helping the Commission analyze proposed changes in the derivatives markets, specifically standardization and centralized clearing of derivatives contracts. While the changes would create transparency, they could also create moral hazard, since the clearinghouse would cover the losses of irresponsible counterparties. RiskFin is helping to evaluate how best to balance the positives and negatives.
  • Market structure. The dissection of the flash crash continues. RiskFin is studying whether a “limit up- limit down” system for individual stocks would be more effective than stock-by-stock circuit breakers, which get triggered only after trades have been put through — even erroneous trades. Other proposals under consideration: a ban on flash orders and the creation of a consolidated audit trail, which would enable researchers to follow an order from start to finish even if it is moved from one market center to another.

Taking a risk-based approach. Donald F. Donahue, Chairman and CEO of DTCC, noted that “Like the old gray mare, risk management ain’t what it used to be.” As a result, the way DTCC monitors and deals with risk has recently undergone a “radical overhaul.” Today, the organization takes a risk-based approach in evaluating all new products, taking a close look at what can go wrong. They focus on:

  1. The risk the product poses to DTCC itself, especially in the case of a “black swan” event.
  2. The systemic risk the product poses.
  3. How the product helps users manage risk.
  4. Whether the product effectively reduces risk through automation of post-trade activities.

DTCC is also re-examing current processes to see how they might be improved along all these dimensions. Trade settlement is one area that they — and regulators on both sides of the Atlantic — are taking a fresh look at. Possible changes: adding intraday net settlements to current end-of-day process, shortening the trade settlement cycle from T+3, and providing for clearer segregation of customer assets, especially in the cash markets.

Also on DTCC’s agenda: separately managed accounts. DTCC is rolling out the Model Management Exchange that will make it easier for managers, overlay managers and program managers to communicate. Morgan Stanley Smith Barney will be the charter client for this program, which will be rolled out before the end of the year.

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