Increasing Collaboration

Counterparty risk and data management have traditionally not been regarded as being part of the same challenge. The collapse of Lehman Brothers, and the subsequent weeks or months it took many data managers to pull data together and estimate exposure to Lehman, changed this view. Now one of the main topics of discussion in the data management world is counterparty risk, and this is fueling discussions on the need for counterparty data standardization and centralization, as well as the need for greater industry collaboration.

During 2009 counterparty risk climbed up the agenda. A poll carried out during the event showed counterparty risk is now one of the top priorities for firms. More than 70% of participants said it was either at the top of the agenda or close to the top. Meanwhile, 19% of participants considered it to be less urgent, and only 8% said counterparty risk is far down their lists of priorities (figure 1).

Still, for the majority, it is important to make changes immediately. In fact, in a poll carried out by Inside Reference Data in 2009, 27% of market participants said counterparty risk was at the top of their lists of priorities, while 46% said it was close to the bottom.

New York-based Darren Measures, executive director, collateral management sales, JP Morgan clearance & agency, said the latest results reveal a step in the right direction. "Last year's results showed anxiety and lack of understanding (of the issues). This year's poll results reveal people are getting their hands around what counterparty risk entails," he said, adding that while the results are not unexpected there is still a long way to go.

London-based Darren Purcell, director, Standard & Poor's fixed income risk management services, said 2009 was dramatically different in this space in comparison to previous years. "Around six years ago, you rarely met people who had implemented these types of strategies, which enabled clients to link instruments to issuers to entities. Clients often said they did see the use of the information, but it wasn't high up their agenda," he said.

The need for good-quality counterparty data has now become more mainstream. London-based Gert Raeves, senior vice-president of strategic business development and marketing at GoldenSource, said there is a waking up to the fact that collectively the industry is re-defining counterparty data as something that is more than just operational. "I do think people looking into liquidity and collateral management and overall financial risk and reporting are getting the message (...) It's all about a mix of better data providers and putting in place better business processes," said Raeves.

London-based Julia Sutton, head of customer data, RBC Capital Markets, said the poll results are very telling and show people do have the right ideas. "We are moving in the right direction," she said, adding that some already have programs in place, some have reached a very advanced level, while others are new to counterparty data strategies, but everyone is trying to get to the same place.

Firms are now recognizing the need for high quality counterparty data. A poll revealed nearly 90% of participants think the importance of effective data management to mitigate counterparty risk is recognized by the industry. While only 10% said it is fully recognized, 43% and 44% said it was partly recognized or not fully recognized respectively. Only 3% of the participants said the importance of effective data management to mitigate counterparty risk is currently not recognized at all (figure 5).

And with the recognition comes the backing. "The projects we have been working on and implemented recently tend to be driven from internal management wanting to reduce the time to calculate exposures," said S&P's Purcell, explaining that these dedicated projects are led by teams that recognize there is a need to improve processes, data and systems.

Data Quality or Systems?

Despite the fact that discussions around the need for good data management to mitigate counterparty risk are now mainstream, more has to be done to improve the quality of counterparty data. Poll results revealed that only 2% of participants estimate a typical firm's counterparty data is more than 90% accurate, and 23% said accuracy levels are between 70% and 90%. Forty-four per cent think the level of accuracy lies around 50-70%, while 8% said accuracy levels are 30% or below (figure 4).

JP Morgan's Measures said that even a 70% level of accuracy of counterparty data is still very low. All market participants will probably never reach 100% accuracy, "but firms should at least have the process in place to understand where, in this case, the majority of the 30% differential is and get the political will to make sure projects are in place," he said.

Poor data quality has been highlighted as the main reason for incorrect counterparty risk assessment. Fifty-eight per cent of participants said missing information and poor data quality remain key challenges, while only 6% said missing or insufficient technology was to blame for most issues. "There is nothing worse than entering a crisis and not being able to trust your data, (you need) understanding of all the different needs and requirements and complications in the market and where the market is versus where it would like to be," added Measures (figure 2).

Meanwhile, GoldenSource's Raeves said the industry is mostly still at the first stage of counterparty data management, meaning firms still have to focus on being able to identify the customer and counterparty, having up-to-date documentation and focusing on data remediation processes. "This is where a lot of the effort is still required and it is where a lot of the market is," said Reaves.

Still, many firms are yet to achieve a balance between their data systems-related efforts and the focus on the data itself - something that becomes more challenging if firms have to deal with different legacy systems. "It is a matter of content, software and hardware, but I don't think the industry has the balance quite right," said RBC's Sutton.

A centralized view would decrease the challenges, but this is not always an easy option. Following mergers and takeovers, firms first have to merge the different systems from different companies. Raeves said people do agree the approach to centralized data management is the way forward, but the reality is not that simple. "It's really all about making the business case and how do you keep the program that will show benefits medium to long term. You don't start from scratch, and people do have to build a very complex and often very time-consuming business plan to get a program in place to manage that data process," he said.

While the scope of the challenge is not diminishing, only 14% of participants claimed poor data quality would be one of the outstanding challenges surrounding counterparty risk in the coming years, and 19% said lack of systems in place would remain a challenge (figure 6).

Yet, other firms continue to struggle with the building in-house versus buying off the shelf question. "I think many of the technology and data quality-related problems we are seeing now are because we (user firms) always seem to try to build in-house. Some banks have to pull out on-boarding solutions built internally," said Sutton, adding that when it comes to reference data, RBC will always try to buy systems from vendors.

The Regulatory Role

While the importance of good data quality has been recognized, the poll results showed that participants still see the lack of defined standards as one of the more challenging aspects of counterparty risk. Sixty-seven per cent said they expect the lack of defined standards to be the outstanding challenge in the counterparty data space in coming years.

Market participants want to see this space moving forward, but progress remains slow due to the lack of an agreed international business entity identifier (IBEI). "As the polls indicate, the lack of standards in the counterparty space is what is causing the inability to move faster to fix this. If we work together there is enough know-how to be able to fix the problem," says Sutton. And change may just be on its way as the European Central Bank (ECB) and Cesr are now planning to facilitate conversations and host meetings on getting practitioners together on what an IBEI should look like, she added.

Regulators could give that added impetus this space requires. Sutton said that while she likes to think the industry should not have to rely on regulators, this is not necessarily the case. "One of the things I have worked on recently with (regulatory think-tank) JWG is the need to get people around a table and work out what should be a standard, and it (this customer data initiative) took off because the regulators were involved," she said.

In fact, regulation could help fuel increased standardization in the counterparty data space. More than 70% of participants said regulation will have a strong part to play. Forty-one percent said the market is already starting to see an emphasis on counterparty risk from a compliance perspective, and 27% said this will be key throughout 2010. Still, more than 16% said regulation has already had its say in this space for a long time, while 16% claimed the regulatory focus is elsewhere at the moment (figure 3).

The regulatory focus on counterparty data may vary from country to country, but it is quite clear that there is a common trend towards more stringent requirements for sourcing and maintaining counterparty data. "From the different regulations, the interesting thing is what level of detail they are going to require in terms of (different) asset classes and how we are going to deal with new securities that come to the market," said S&P's Purcell.

So far, the market remains fragmented and questions are yet to be answered. Panelists said it is not clear who is driving the agenda in the counterparty data space, and what will be the most important change when it comes to compliance. "People are familiar with the variables, but I cannot see who the driving force is. Many people are still sitting on the fence. It is not clear what the speed of any political move or infrastructure change will be, and I think that is what explains it," said Raeves.

However, firms cannot wait for the implementation of a bussiness entity identifier. Collaboration also remains key when it comes to proprietary identifiers. Purcell said companies have to choose one global provider and then ensure they also take other global sources. The ISIN, for example, is one standard but it is also a collection of different sources put together, he said.

"At the moment if you are a larger company you are going to need multiple sources and treat it as you would (treat) a pricing feed ... the likelihood is you are going to have to handle multiple sources and that these sources will have multiple identifiers and that you would need some capabilities to link and manage those identifiers," said Purcell.

It is this requirement for several sources that has made the collaborative model popular in the industry. "Whereas some companies will be strong in African companies, others will have Canadian information," said Sutton, explaining that by working together, firms can improve coverage and efficiency.

But for now, the counterparty risk challenge is ongoing. Firms are well-aware of the challenges, and recognition has led to greater support from top management. The regulatory push has also resulted in market participants being more willing to collaborate to solve problems that may have been fixed internally - but problems that are yet to be solved at an industry level.

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Moderator:

Panelists:

Carla Mangado, Inside Reference Data

Darren Measures, JP Morgan

Darren Purcell, Standard & Poor's

Gert Raeves, GoldenSource

Julia Sutton, RBC Capital Markets.