The leading knowledge platform for the financial technology industry
The leading knowledge platform for the financial technology industry

A-Team Insight Blogs

Serious Scientific Task Awaits the OFR and FSOC, Says Systemic Risk Focused Academic Liechty

As well as the data standardisation challenge, the Office of Financial Research (OFR) and the Financial Stability Oversight Council (FSOC) also face the “significant scientific task” of understanding how to use this data, according to academic John Liechty, professor of marketing and statistics at Smeal College of Business for Penn State University and director for the Centre for the Study of Global Financial Stability (see his CV and bio here). During last week’s government organised conference on financial stability and the OFR, Liechty, who was one of the lead champions for the precursor to the OFR, the National Institute of Finance (NIF), highlighted the true scale of the challenge ahead of the recently established bodies: “not only do we not have the data in place, we have not done the science needed to understand system-wide risks to the financial system.”

He compared the challenge of understanding the data (once it has been collected, that is) to the task of interpreting complex weather data when the US National Oceanic and Atmospheric Administration (NOAA) was first established. However, given the complex nature of many of the data items in question, including accounting data, internal risk reports, transaction and position data (as listed by Liechty), the challenge is likely to be even greater.

Much like Berner, Liechty is also convinced that the new data standards that will be established by the OFR’s efforts will prove useful to the industry in terms of improved risk management and “operational savings,” also thus ignoring the potential of the standards to become just another cross reference. He reckons the requirements will compel firms to get their back offices in order, rather than in resulting in tactical workarounds.

During his speech, he noted the “disarray” that most firms’ back offices are in with regards to capturing basic reference data items and the “time consuming” task of producing comprehensive risk reports as a result. He also indicated that he is aware of the need to avoid duplication in the reporting process, but suggested that: “With regards to detailed transaction and position data, the OFR will be collecting data that has never been collected in a systematic manner by regulators; hence these data collection efforts will not represent a dual reporting burden.” This statement perhaps belies the US-centric view within the OFR, given that transaction reporting has been happening under MiFID in Europe (albeit with mixed results) since it was implemented in 2007.

He also stressed the need for a consistent source of identifiers, which is at the heart of the OFR’s recent efforts in the legal entity identification space and beyond. To this end, he noted three main benefits that would stem from the adoption of these IDs and transaction reporting: “First, firms would have an electronic copy of all of their transactions reflected in their central IT systems, at the time that they are settled and they would be able to routinely produce risk reports that reflected all of their firm’s exposures. Second, it would be relatively straightforward for firms to provide an electronic cc to the OFR when transactions settle – allowing the OFR to build a comprehensive view of the financial system and then share this data with the members of the FSOC. Third, it would result in dramatic operational savings for the industry. The universal identifiers are needed in order to allow OFR to build a consistent counterparty network; they are also essential for helping market participants reduce order matching errors.”

These benefits, of course, are all dependent on firms ripping out and replacing their old legacy back office systems in order to accommodate the data in a central repository and the OFR having the ability to make use of the mountains of raw data it will accumulate…

From a high level regulatory perspective, Liechty stressed the importance of getting the systemic risk monitoring infrastructure in place to be able to prevent a future crisis. “If we can’t get this right and there is another crisis, then there is a very real risk that the political response may result in a response that adversely affects the financial market’s ability to innovate,” he warned.

In terms of systemic risk analysis and potential scientific approaches to this new field, Liechty discussed a range of “important elements” that must be incorporated in systemic risk models (all of which can be seen towards the end his testimony in the document below), including environmental and historical factors.

Moreover, he ended his speech last week with a call for the US government to nominate a director of the OFR ASAP: “Until that happens, the OFR will be limited in its ability to become established and help provide the insights that we need.”

Related content

WEBINAR

Recorded Webinar: Entity identification and client lifecycle management – How financial institutions can drive $4 billion in cost savings

A new model in Legal Entity Identifier (LEI) issuance has created significant opportunities for financial institutions to capitalise on their KYC and AML due diligence. By becoming Validation Agents and obtaining LEIs on behalf of their clients, financial institutions can enhance their client onboarding experience, streamline their internal operations, and open the door to new,...

BLOG

Refinitiv Teams with MarketPsych to Launch ESG Analytics

Continuing its focus on adding capabilities with an ESG theme, Refinitiv has teamed up with Los Angeles-based MarketPsych to launch Refinitiv MarketPsych ESG Analytics to monitor perceptions of sustainability and ESG risk. The analytical tool draws upon news and social media monitoring to offer analysts and portfolio managers numerical insights into companies and countries of...

EVENT

TradingTech Summit Virtual

TradingTech Summit (TTS) Virtual will look at how trading technology operations can capitalise on recent disruption and leverage technology to find efficiencies in the new normal environment. The crisis has highlighted that the future is digital and cloud based, and the ability to innovate faster and at scale has become critical. As we move into recovery and ‘business as usual’, what changes and technology innovations should the industry adopt to simplify operations and to support speed, agility and flexibility in trading operations.

GUIDE

Entity Data Management Handbook – Seventh Edition

Sourcing entity data and ensuring efficient and effective entity data management is a challenge for many financial institutions as volumes of data rise, more regulations require entity data in reporting, and the fight again financial crime is escalated by bad actors using increasingly sophisticated techniques to attack processes and systems. That said, based on best...