Originally appeared in MiFID Monitor
Although the market is experiencing a period of significant turmoil, financial institutions that embrace new business models and invest selectively in technology innovation will survive the crisis, according to a recent report by TowerGroup. The report, “A Bumpy Flight, Landing, and Takeoff for the Financial Services Industry”, indicates that risk management approaches will also be key for the future.
Financial services institutions and industry providers should prepare for the future and respond to the evolution of their markets by employing the new enabling technologies, the report warns. Guillermo Kopp, author of the report, indicates that advances in technology will act as a “catalyst” for improved performance within these institutions.
Moreover, he claims that in order to prevent irreparable loss of confidence in the financial industry, these institutions and regulators must take prompt and concerted action to establish an integrated risk management framework. “Most institutions are renewing their focus on risk of various types: systemic, counterparty, and other critical risk types. Having to upgrade to more integrated governance frameworks and technologies will drive financial services institution boards to re-evaluate their leadership teams’ risk management acumen. As TowerGroup has long pointed out, a holistic view of risk across the enterprise of risk enables any FSI to optimise its business strategy and capital allocation,” the report states.
The report sings the praises of an enterprise-wide approach to risk management, which it says allows for a fuller assessment of counterparty risk, client segmentation, and relationship pricing. Realistic risk ratings and asset valuations will also “instil confidence” in the markets, it continues.
TowerGroup highlights five areas of improvement for institutions with regards to dealing with what it calls “critical risk factors”. These include rebuilding confidence and trust through more transparent valuations and asset pricing and preparing for a surge in regulation by revisiting the approach to risk management with the right people, skills, and tools to balance risks versus rewards. Also, spreading the liquidity and credit risk by broadening the sources of funding with retail deposits and balancing defensive strategies with proactive innovation in business models, integrated processes and advanced technologies. It also recommends that institutions partner with an ecosystem of industry providers that deliver optimal value to the end clients.
Globalisation will also continue to gather momentum over the next year, according to the report, and this will mean that smaller players will be forced to adapt as well as the larger players. “Institutions must interconnect with an ecosystem of providers to deliver optimal value to the end clients,” the report warns.
IT budgets must be spent carefully in such a constrained environment, says Kopp. ”The objective now is the consolidation and rationalisation of technology resources to reduce spending and free up investment capacity for a few vital projects. This approach has spurred a surge in technological innovation. For example, client facing, collaboration, and risk management technologies are in vogue. Transaction data, multimedia streams, and ancillary real-time information volumes are growing robustly. Data processing power, storage capacity, external software services, and governance tools across the enterprise are getting renewed attention,” he claims.
The report draws attention to the lingering threat that counterparty risk poses to institutions. “Most financial services institutions s are ill prepared to assess how further deterioration in markets and ratings may indirectly affect the credit and liquidity situation of other institutions and commercial companies with whom they have business interdependencies,” it says. Part of the problem can be tackled by the rationalisation and consolidation of duplicative systems and infrastructures, the report contends.
The regulators must also work together to put the industry back together in working order, it continues. “The global mesh of complex and interdependent financial instruments has run out of control and needs an overhaul. Regulators also must orchestrate a disciplined and consistent industry-wide framework of sound principles and practical rules swiftly and judiciously to avoid stifling growth and innovation. A broader challenge is to minimise the customary lags by local jurisdictions and reluctant institutions to implement global guidelines,” it recommends.
“To restore vigorous and sustainable growth, institutions and regulators in the leading financial centres must align with global standards; reaffirm the rule of law; improve the quality, speed, and transparency of execution; and nurture a culture of openness and innovation. Adequate transparency, coupled with the continual disclosure of a vital set of common risk and liquidity indicators by all participants in quasi real time will be key to maintaining the equilibrium between multiple and increasingly interdependent financial centres,” the report concludes.