Market volatility casts spotlight on realtime risk analytics

NOTE: This article was originally published on GlobalInvestorGroup.com by Radi Khasawneh.

The prolonged volatility roiling markets has forced firms to think again about their risk and liquidity management systems, according to senior executives at systems provider ION Group.

Francesco Margini, head of product management for cleared derivatives at ION Markets, says there has been a spike in demand for its services since the pandemic-related market disruption in March 2020, which has accelerated through to the extreme price moves in European power markets observed in recent weeks.

“The structural weaknesses of the market in dealing with periods of extreme volatility have come to the fore with the prolonged disruptions we have observed since Covid,” Margini told Global Investor. “That unique situation, with persistent volatility, exposed those deficiencies in the cleared derivatives space and resulted in firms having to scale up their capabilities operationally and from a technological perspective.

The new reality that has emerged in the commodities space, in particular with the recent dramatic shifts in energy prices, has shown where sophisticated risk management really comes into play for firms. The issue has moved from a structural one to one that differentiates between individual participants, with those well equipped to manage risk in an efficient manner coming to the fore.”

For ION Markets, that has meant an influx of requests from corporate clients who use the software giant’s treasury services to upgrade their risk management capabilities, representing an expansion of its traditional client base of brokers and futures commission merchants.

“The capital markets division has primarily served the sell side, but increasingly corporate clients who already use our commodity and treasury management services are seeking to expand their use of our solutions to include derivatives risk management,” Margini said. “That is unusual historically, but global corporates now need tools that help their understanding of market and liquidity risk. It’s a fundamental need to understand the cost of trading and maintaining derivatives positions in the new environment.”

At the end of last year, ION marked a notable expansion by onboarding commodity merchant Louis Dreyfus Company. The large scale of the firm’s operation and hedging activities provided a good use case. Sophisticated buy-side firms have also been keen to avoid getting caught by the liquidity issues disrupting holders of derivatives positions as they seek to understand central counterparty (CCP) requirements.

“The traditional buy side already had a very good view of market risk, as an obvious offshoot of their normal activities, but the problem many have been unprepared for is the liquidity management dimension,” Margini said. “They got caught out by huge margin calls on the back of price shifts and increased margin rates by CCPs in line with their risk models.”

“So, in addition to our core sell side clients, we have seen institutions expanding their use of these services after the massive spikes in prices, and the risk and liquidity effects on requirements from intermediaries.”

Speaking at a European Energy Exchange conference in London on Thursday, experts said there is increasing evidence of shifts between the cleared and OTC markets in the context of changing margin and collateral requirements. The ability to aggregate that information across those markets, with real-time valuation of positions and calculation of initial margins is being more widely requested by firms, Margini says.

“It is becoming increasingly important to have the ability to assess counterparty and liquidity risk and on an intraday basis, through the realtime calculation of margins,” he added. “Where clients typically pledge cash and collateral on a T+1 basis, intra-day counterparty risk and liquidity margin management has become a crucial capability for the firms that provide services to their clients.”

Mirko Marcadella, chief product and marketing officer at ION-owned LIST, says the trend is likely to continue as risk models rely on data that reflects these prolonged bouts of volatility.

“Our experience with providing that service to a wider universe of firms shows that there is a strong trend emerging,” said Marcadella. “With no sign that markets will stabilise in the near term, it is becoming clear that real-time margin and liquidity assessments are a necessary tool to run these businesses. What we can do is provide a full stack integration as they use these new tools and capabilities beyond basic position management systems they are more familiar with. It’s an ongoing process, but the ability to provide all these services in an integrated ecosystem has been a differentiator.”

LIST, based in Pisa, is a longstanding risk analytics providers that manages and deploys ION’s pricing and valuation platform, called JANUS. ION has targeted the cleared OTC market for its next phase of expansion, after buying OTC data specialist Clarus Financial Technology in a deal announced last September. The combination with cross asset exchange-traded derivatives (ETDs) will give clients more flexibility as they navigate these constraints, the firm believes.

“We have identified workflows for the holistic solution across ETD and cleared OTC markets, and identified integration points in line with client feedback on how they would like to use it,” Marcadella said. “So the effective work has now started and should be available in the coming months, with an expectation of rolling out that capability in the second half of next year. It’s a horizontal extension that very much sits alongside our extensive coverage in terms of instruments.”