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Regulation and Risk Will Force Banks and Hedge Funds to Tighten EDM Controls, Says Tabb Group

Current market conditions and the threat of impending regulatory changes will force banks and hedge funds to revise their enterprise data management (EDM) strategies to improve transparency, according to recent research from analyst firm Tabb Group. Adam Sussman, director of research at the firm and author of the report, reckons requirements for better risk management and the need for “know your counterparty” data will prompt institutions to revise EDM systems.

“Measurable improvements must be made to operational controls to detect frauds like the Madoff Ponzi scheme and prevent rogue employees like Jerome Kerviel from jeopardising a firm’s bottom line,” says Sussman. These improvements come in the form of increased operational efficiency and risk controls, as well as improved Excel spreadsheet management capabilities and efficient calculation engines, he explains.

The new report, “The Enterprise Spreadsheet: Pushing towards Transparency”, highlights the market requirement for firms to increase transparency and meet additional regulatory reporting requirements via improvements in their EDM efforts. Sussman explains that risk management will focus on gaining a better understanding of market risk, operational controls and the need to not only know your client, but also “know your counterparty better”.

The report draws on recent Tabb Group research, which indicates that 60% of the buy side participants interviewed said counterparty risk is now an important part of trade allocation decisions. Counterparty data is therefore a key investment area for these firms in the current climate and this is exacerbated by the diffusion of business across multiple counterparties.

Sussman explains that financial institutions are being compelled to imbue their new product offerings with regulatory, compliance, operations and risk safeguards. “We’ve moved from the sandbox to the stadium,” he says, “where tension between flexibility and control begins to sprout. Moving from the front to the back office, the types of requirements lurch from flexibility and openness to standardisations and control, from spreadsheets and desktops to applications and servers. But this is a false duality.”

He believes that the creation of a risk regulator is “inevitable” and it will force banks and hedge funds to invest in systems to improve their data around more complex products. However, he points to Tabb Group research that indicates implementing a more tightly managed environment should not impede innovation. According to the research, 60% of the OTC derivatives markets participants are currently being driven by customisation requirements and this is unlikely to change, he claims.

Sussman highlights the fact that Excel is one of the most often used applications on the trading desk: “Based on Tabb research, 47% of the buy side use Excel to price OTC options and 41% use it during the post-trade process.” He reckons that despite its shortcomings, Excel is a valuable tool: “Spreadsheets, either alone or in conjunction with other components, can meet the same requirements as a business application.”

Although Excel cannot satisfy the requirements of a whole enterprise, it has been embedded in many critical components of capital markets, says Sussman. Due to its association with manual processes, its ubiquity has been accepted but perhaps not welcomed, but this approach “oversimplifies the issue”, he adds. “With the advent of better enterprise controls and support of high performance computing, seeing a spreadsheet as part of an application framework is no longer foreign or scary.”

Sussman concludes that there are many challenges ahead of financial institutions as a result of the current environment. “Regardless of whether a brokerage firm services institutional investment managers or retail clients, the rules of engagement are changing. Similarly, whether an investment management company is running a 40 Act fund or a private investment vehicle, increased disclosures and fiduciary obligations will be required. While Tabb Group does not believe that any part of the financial landscape will be legislated out of existence, regulatory requirements among different entities will converge,” he elaborates.

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