Swift may be keen for a utility approach towards business entity identification (BEI), but the vendor community is not out of the picture just yet. Reference Data Review speaks to Darren Marsh, business manager of risk management and compliance services for Interactive Data in Europe, about his own firm’s endeavours in this area and the potential challenges for the future.
There can be no doubt that recent events have brought counterparty risk and risk management in general to the forefront and this has underlined the importance of BEI. “Lehman Brothers helped to demonstrate why it is essential for an institution to understand both its direct exposure to an individual counterparty and also indirect exposures to entities related by the same parent organisation,” says Marsh.
For example, it would be a relatively straightforward task to identify securities issued by Lehman Brothers but a much more difficult task to calculate exposures in its subsidiary companies. This is where business entity data is essential in identifying entity relationships, he explains.
The focus therefore in the short term should be on maintaining an accurate, consistent view of entity data available across the organisation in order to effectively manage counterparty risk. Technology is the enabling factor here, says Marsh: “Manual collection processes built around specific business functions can result in inconsistency and duplication, which makes it difficult to identify exposures across an organisation. “
To this end, Interactive Data offers a business entity service that provides clients with entity data linked to its range of security level reference data. The business entity service can help clients to identify potential exposures by monitoring parent-subsidiary relationships as they relate to their holdings, claims Marsh.
In the long term, it is clear is that the industry needs to collaborate on a solution, he continues. Marsh does not feel a utility approach is mandatory for this space: “Firms, data vendors and software vendors need to bring the disparate worlds of entity data together with instrument data, and then enable informed decisions to be taken upon them.”
Recent reports have suggested that hedge funds are also investing in the area of counterparty risk management and Marsh reckons that entity data is equally important for both buy and sell side market participants. “The need to manage risks in a holistic and enterprise-wide way are not sell side or buy side specific. Firms need to manage risks that are commensurate with the business services that they provide. There is a relationship between risk and reward. Understanding and managing the risks involved in the pursuit of higher rewards is not the same as being unaware of the risks. It seems inevitable that the higher the risks involved, then the higher the sophistication that is needed in pursuit of these higher returns,” he elaborates.
Given the limited budgets in the market, Marsh reckons remaining dollars are being spent in targeted areas. “We feel that institutions are focusing on the accuracy of their reference data and ensuring that it is consistent across asset classes throughout the organisation. This may include centralising collection and data management, and automating manual collection processes through outsourcing,” he explains.
The current climate will make it necessary for institutions to re-evaluate some projects, he adds. “However, in our experience this is less likely to affect that content that can drive mission critical processes.”
Greater regulatory scrutiny is also having a significant impact on issues that may affect counterparty data management practices in the future. “Globally, regulatory bodies have recognised a lack of transparency as a major factor in the recent crisis. As a result, a new systems and controls framework has been recommended by the Basel Committee on Banking Supervision (BCBS) and the Committee of European Banking Supervisors (CEBS). Most recently, these recommendations have been adopted by the Financial Services Authority (FSA) as a major component of the new liquidity risk regime (CP08/22),” says Marsh.
Regulations such as UCITS and Basel II have well-defined compliance requirements around counterparty risk. “For UCITS, fund managers need to be able to measure the counterparty risk exposure at both the individual issuer level and at the group level where issuers are related by a common parent to ensure compliance with the limits set by the regulator,” he elaborates. “For Basel II, banks are required to map issues to issuers and monitor relationships between counterparties as part of their capital adequacy calculations.”
However, there are a number of regulations where the same basic information, such as business entity data, is also required, adds Marsh. This includes MiFID for monitoring conflicts of interest, Know Your Customer (KYC) and anti-money laundering (AML) for client on-boarding purposes.
As for future challenges and where firms should be focusing their energies, Marsh reckons centralisation is the only way forward. “In order to get a true feel for the level of counterparty risk exposure, it is essential that the relevant data is collated across the enterprise for risk reporting. Institutions will need to establish a centralised view to ensure consistency of their data and support the in-house distribution frequencies required across the individual business functions. As we have seen with the FSA’s liquidity risk proposals, new risk regulation will be a major driver in determining the scope and frequency of risk reporting.”