Regulatory and compliance requirements, plus the changeable nature of the international marketplace, make flexible and dynamic technology an absolute necessity in the modern derivatives industry, writes Alex Tsigutkin.

The booming global growth in derivative financial instruments and markets has been marred periodically by highly publicized disasters such as the failure of Barings Bank, and each market misstep seems to breed a new rule or regulation.

Today's financial controllers, compliance officers and risk managers must deal with an outpouring of external and internal reporting requirements. Each report may differ in nature and scope, ranging from trade surveillance and financial controls to broader issues such as capital adequacy and counter-party risk. However, all reports, regardless of their ultimate purpose and destination, are based upon a financial institution's transaction activities.

SOFTWARE AND TECHNOLOGY SOLUTIONS DESIGNED TO MEET REGULATORY AND COMPLIANCE REQUIREMENTS MUST BE DYNAMIC AND FLEXIBLE

Software and technology solutions designed to meet regulatory and compliance requirements must be dynamic and flexible to handle rapidly shifting market, institutional and external needs. Just as importantly, the software must be able to generate a wide range of informative and timely reports which will provide management and regulators with both the standard and the special information required to fulfill their responsibilities.

In the global financial arena, financial institutions must respond to the demands of diverse multinational and national regulatory bodies, including central banks, exchanges, and securities industry regulatory bodies.

The key to success in this complex reporting and compliance environment is being able to consolidate the vast amount of relevant transactional information from front and back offices systems throughout the enterprise, as well as to utilize information at times from the customer base and from external data sources.

Intensive Packaging

Today's technology offers the ability to intensively manage and package information with the help of a rules-based aggregation engine. Institutions operating in a system lacking a robust and intelligent engine which can follow instructions and seek out information will find the task of managing operational risk is infinitely more difficult.

As financial firms reconfigure and structure data to meet reporting needs, rules defined using simple business terminology single out relevant pieces of information within the database and send it to the appropriate parties. The rules can easily encompass a specific report required by regulators and auditors, and it should also be possible to configure these reports to meet professional accounting standards or internal management requirements.

THE KEY TO SUCCESS IN THIS COMPLEX REPORTING AND COMPLIANCE ENVIRONMENT LIES IN BEING ABLE TO CONSOLIDATE THE VAST AMOUNT OF RELEVANT TRANSACTIONAL INFORMATION FROM FRONT- AND BACK-OFFICE SYSTEMS

Business rules play an extremely important role in setting the foundation for managing a wide range of risk. A typical set of rules should perform a number of important roles. It should enable the user to create a set of instructions for data aggregation to be used in a compliance/financial control report, and to view the balance sheet (or portions of it) from the same perspective as a regulator/auditor. It should also address trade surveillance issues, such as exceptions, and identify suspicious and abnormal trading activities.

The creation of Value At Risk (VaR) portfolios, by applying a rules definition to the data, is another important function of such rules. A set of business rules for a typical VaR Portfolio is defined no differently from other business rule definitions, but in actual use the VaR definition is broader in that models may be assigned to the instruments included within the definition. A typical set of regulations should also meet internal business, control and audit requirements.

Dynamic Data

Of course, there are many more ways in which business rules can be implemented. No business rule will be very effective, however, without dynamic data delivery. Application-generated elements , and corresponding data warehouse components, must be dynamically adjusted to accommodate the defined business rules. An aggregation engine, working with a data warehouse, should facilitate enterprise-wide data integration and data delivery to the applications.

Top-flight solutions

Once the relevant data is available in the needed format, it is necessary to analyze it in order to meet more sophisticated regulatory and internal mandates. A top-flight solution for meeting regulatory and management information needs should carry an analytical module for in-depth review of consolidated information. There also should be capability for manual data entry and adjustments to the data. In a rapidly evolving marketplace, users frequently want to produce their own ad-hoc and periodical reports.

TO MEET DEADLINES, REPORTS NEED TO BE PRODUCED WITHIN MINUTES, SO THAT THE ANALYSTS HAVE THE TIME TO REVIEW AND CORRECT FIGURES WHERE NECESSARY

Viewing all the information should not be a burdensome task. A controller or compliance officer sorting through streams of data needs a user-friendly graphical user interface that allows in-depth analysis or adjustments. Financial information needs to be available on a global or local level. Data should be re configurable with a simple click of a button to view details by any defined group, such as general ledger, customer type, etc. Transaction-level disaggregation should permit drilling down to the lowest level of granularity. And, to meet deadlines, reports need to be produced within minutes, so that analysts have the time to review and correct figures where necessary.

Various types of operational risk have drawn increasing attention in the wake of Barings and other scandals. No system or technology can guarantee to stop a "rogue trader, or to prevent individual misdeeds, but there are many ways in which an alert management and compliance function can use technology creatively to reduce significantly the possibility of these.

It is possible, for example, to have a system which can do pre-trade review and approval in real time, which can scan transactions on an intra-day basis and which can selectively apply business rules during the trading day to identify any unusual transactions. The appropriate system can allow a trading manager and a compliance officer to review data by desk, product, ledger, trader and counter-party, or by other relevant categories. It is also possible to make available a hard copy audit trail of transactions producing an exception.

Unquestionably, meeting regulatory, compliance and operational risk management needs is an extremely complex task in an era of rapidly evolving global financial markets. Just as clearly, however, the technology and systems to meet these challenges are available and are being implemented by leading financial firms around the world.

Alex Tsigutkin is president of Axiom Software Laboratories.

This article was originally published in Trading the Future, an official publication of the UK Futures and Options Association, and appears with their permission.