WHITE PAPER

A FRAMEWORK FOR REAL-TIME RISK AGGREGATION

A FRAMEWORK FOR REAL-TIME RISK AGGREGATION

Introduction
Many of the most serious challenges facing banks boil down to this: how to get the information required to understand risks and opportunities in a format and timeframe that enables effective decision making. It is not just traders and risk managers who need this information, but business unit managers, product developers, strategists, compliance officers and, of course, members of the board. The problem is that the source of this information is spread across many underlying processes, locations and systems that were set up to meet specific business needs. Although the systems are often fine-tuned for the particular asset class or risk factor they support, they do not talk to one another and were never designed for higher level data aggregation and analysis. So banks end up with a litany of complaints. They are unable to see exposures in real time. They have no consistent view of aggregated risk across asset classes, no single view of market risk, no consolidated view of exposures by counterparty and no consolidated view of market and credit risk. At the same time, it takes too long to bring new products and businesses to market, to integrate them into the banks risk and systems architecture and no single way to define complete trades. Banks are faced with an urgent need to improve the transparency and visibility of their risk. However, the problem of accessing underlying data and turning it into timely information is in fact a perennial issue for business. So, the overall architecture of the solution can be generic and applicable in many contexts across the industry. But attempts to build it with generic technology standard tools for data management, business analysis, grid computing, etc.can lead to a less than adequate solution. The particular nature of financial markets, with their speed and complexity, vast volumes of data and the need for flexible, high performance calculation and analysis, calls for a solution that is fully optimised for todays financial environment.

OVERCOMING THE CHALLENGES

As any bank that has attempted to integrate its systems and extract and aggregate risk information knows, there are significant challenges and bottlenecks to be overcome in terms of data, performance, scalability, openness, transparency and implementation.

Data The options Most banks have significant investment in their existing trading and risk systems and in the processes they have built up around them. Ripping them all out and starting afresh with a single unified solution is not usually an option. Even where it is, it can mean replacing finely tuned best-of-breed systems with an unsatisfactory general purpose system. Meanwhile, in-house integration programmes built around point-to-point system connections and data mapping, transformation and warehousing are resource intensive and time consuming and can lead to overly complex, inflexible and cumbersome solutions. This is the number one challenge. The volume of data in finance is massive and grows relentlessly. It is held in many different systems and is often incomplete, liable to contain errors and in inconsistent formats. Meanwhile, those who want to examine the data want to look at a range of different extracts and combinations, and these can change over time. Moving vast volumes of data around for aggregation and analysis can be painfully slow and consumes resources.

Hyper Rig has achieved a breakthrough in tackling these problems by virtualising the data. What this means is that users no longer need to know any of the specifics of the data physical location, storage medium, access protocol, format, etc. This is all taken care of by the Hyper Rig Data Manager, which keeps track of the data and takes care of the cleaning, enrichment, transformation, aggregation, etc. The Data Manager also has the intelligence to understand what users mean when they ask for the market risk of their equity options, or the exposure to a specific counterparty across asset classes and geographies, or consolidated market and credit risk. It is able to go away and find the relevant data, make sure it is clean, perform any necessary transformations or calculations, aggregate it in the appropriate combination, and deliver it to the user in a form that is accurate, consistent, sensible and timely. One of the key elements of virtualisation is that instead of trying to gather all the market data into a huge data warehouse that can end up becoming an isolated data island, it leaves the data where it is, but tags it so it can be found as and when needed. This allows those who know the data to continue to manage it, while still making it available to the organisation as a whole. It also avoids the problems that arise in traditional systems when there are structural changes to the data, such as a change in format or the addition of a new field, where the subscribing services to the data have to be reprogrammedoften a time consuming, costly and error prone process. One way to understand data virtualisationand the power that it gives to usersis to think of it like Google. If it is time for lunch and you are wondering what to eat, you can type sushi restaurants City into Google and it will shoot back a list of appropriate restaurants and links. This is not because it had been pre-programmed for your enquiry, or has all the particular data neatly stored in a warehouse somewhere, but because it understands the question and

knows where to look for the information. You simply have to specify the data elements (sushi restaurants, City), and define their relationship (in this case there is an implied and), and the system delivers what you want. Similarly, Hyper Rig allows users to specify data elements and define the hierarchy in which the elements should be combined. The system goes away and finds the data by its tags and performs whatever processes are necessary on it, and delivers the answer.

Performance Many of the calculations for risk, especially Monte Carlo simulations and other stochastic analysis, are so computationally intensive that a full recalculation of portfolios can only be carried out overnight with traditional technology. Meanwhile, the demand is for intraday and pre-trade analysis and real-time limits and exposure monitoring. Hyper Rig has achieved a breakthrough in performance through the use of intelligent distributed grid computing and optimisation techniques based around the idea of reuse. With Hyper Rigs intelligent distributed grid, computational tasks are divided up into small chunks and distributed across the grid for processing in parallel. In doing so, Hyper Rig avoids two of the major stumbling blocks to effective grid-based parallel processing. First, it is able to distribute the load effectively across all nodes of the grid, thereby avoiding the bottleneck where certain nodes end up doing most of the work. Second, it is able to push the data out onto the grid fast enough to really take advantage of a parallel processing architecture. Some conventional grid implementations take so long to push the data out that it negates any gains from parallel technology. A third innovation that brings significant performance gains is the way in which Hyper Rig maintains the data on the grid and takes

processing to it instead of the other way round. The data lives out on the grid, and rather than being fully recalculated each time there is an event, it is updated incrementally only when and where necessary. This greatly reduces the amount of data that must be moved around the grid. Unlike generic grid management technology, Hyper Rig understands the nature of financial data and its related processing so is able to cluster work and data together in the most efficient manner. As a result, Hyper Rig is able to achieve smoother load balancing across the nodes and improvements in efficiency for risk analysis by several factors compared with conventional grid processing. As a result, what used to take all night can now be achieved in seconds or minutes, even for Monte Carlo simulation-based risk analyses

Transparency Many Financial Institutions also require open and transparent risk platforms in order to address risk holistically and achieve consistency across their business lines, from large books of vanilla products to exotic OTC products with non-linear pay-offs. For example, they deploy analytics models that have been specifically designed (either by their internal quant teams or using third-party providers such as Numerix) for the instrument it is valuing. But even when those models have been perfectly implemented, inconsistencies can remain between the models used for each instrument on a firm-wide basis. For example:

Smart aggregation Traditional risk management solutions treat risk aggregation as the final step in a linear process that begins by calculating risk measures for each trade and finishes by aggregating the results into pre-defined risk reports. This approach is slow and rigid. New reports or variants on an existing report require reprogramming, which can take months, and then join the long list of reports being run over night. With Hyper Rig, users create aggregation hierarchies sets of data rules that operate dynamically in real-time. Any number of new hierarchies can be created which live on the data grid as entities. When a change in the risk environment occurs, such as a new trade or a new price, Hyper Rig updates all the hierarchies dynamically, with the results available immediately.

Each model makes (explicit or implicit) assumptions about the future states of underlying risk factors, which means that the modelling of the future is tied to each individual instrument, rather than to the risk factors themselves, and is therefore not standardised across trading desks or even the whole firm. Each model is calibrated to a set of observed market prices, but again the values used for the calibration are often limited and instrumentspecific, rather than being more broadly representative of the market. Consequently, while positions are correctly calibrated and priced in isolation, this instrument centric approach to modelling creates inconsistencies in the valuation process that can affect hedging and risk assessment in general. Although this is not model risk in the strictest sense (as there is no real incorrect specification or use of a model), this creates reconciliation issues from instrument to instrument when positions are aggregated at business line or enterprise level.

Hyper Rig can address this consistency issue by interfacing seamlessly with external pricing models such as Numerix in order to: Retrieve trade and market data and map to standardised risk factors Generate market-consistent, risk-neutral scenario sets for any number of economies that can then be accessed throughout the enterprise across a wide range of interfaces Create unified hybrid models (see example of hybrid model above) that capture correlation among asset classes and across asset classes while keeping control over model choice, market data, calibration parameters and calibration sets

By providing a set of valuation analytics like Numerix, HyperRig solves the risk problem more holistically because not only does it allow for pre-trade analysis, MtM calculation and P&L attribution by curve, volatility or time for all derivatives across all asset classes, but it also helps to: Reduce model risk by enabling precise calibration of multi-factor models, allowing the user to specify component models and correlation, and then apply a joint calibration process to accurately capture the observed market dynamics of each risk factor Easily configure stochastic processes for riskneutral valuations, including higher-order Greeks (i.e., component-level delta and gamma, key-rate rho and vega across prescribed tenors).

 Audit and challenge model assumptions and inputs, stress test the impact of change on a parameter and shift multiple market parameters simultaneously On-board new instruments easily, because at the end of the day, most aggregated risk measures (VaR and/or PFE, CVA) are non additive and non linear measures. Even if one derivative is not properly valued in the customers portfolio, there is no true indication of risk. Provide complete deal transportability in a common language that can be easily read by humans and machines with drastically reduced operational error.

with the sudden spikes in market volatility or financial crises that demand urgent analysis while maintaining a high level of utilisation of grid resources. Hyper Rig handles business growth by simply extending the grid and creating more work units to cope with the additional load. Hyper Rigs performance optimisation techniques mean that it can handle even the largest portfolios and risk calculations in intraday timescales.

Implementation Hyper Rigs design and approach to data management and grid processing simplifies and speeds up the implementation process. Hyper Rig avoids the intellectually and technically demanding task of mapping and integrating data from many source systems, and tags the data instead. Also, because Hyper Rig has an expert understanding of its domain, it selects only the data that is necessary for risk analysis. This data is relatively few compared with the mass of information that systems hold for trade processing through to settlement. This reduces the burden of implementation and operation. Hyper Rigs implementation tools minimise the need for programming or complex integration projects. Instead, much of the implementation can be carried out by business analysts and in a fraction of the time it takes for traditional systems integration programmes.

Scalability Banks need to know that their key systems can grow with their business. This doesnt just mean slow and steady expansion, but the dramatic growth in several dimensions that has become a feature of todays industry. Will systems cope if business grows from 10 trades a day to 10,000? Or, if the dealing room expands from 10 traders to 100, or to 1,000? And, will they still provide the same level of performance and functionality. Day-to-day volatility is likewise a challenge. Recently, there have been instances where quote and trade data on certain markets has doubled overnight. The financial crisis saw enormous volatility across markets. Can the system cope with these intermittent fluctuations, as well as scale up for overall business growth? Hyper Rig manages the short-term volatility of processing requirements by creating new work units on the grid to meet new processing demands. Under normal loads, part of the grid is configured for risk processing, while the rest is available for the banks other IT tasks. As demand increases, intelligent control software automatically scales back the non-priority IT tasks and commandeers the freed-up grid nodes for risk processing. This enables the grid to cope

Conclusion Hyper Rig is a flexible solution that slots into a banks existing technology infrastructure. It preserves an institutions investment in its data and trading systems, while easing the task of integration and facilitating access to the underlying data. Hyper Rig provides an intelligent, expert and highly efficient platform which enable users to ask any question about their risks and opportunities without having to pre-program the system or know where the data is located. It creates a highly efficient distributed grid platform that can process the data and return the answers to the questions in the timeframe that users require. Hyper Rig is the result of many years of experience and thought by its development team. It brings leading edge technology to bear on some of the most pressing problems facing banks. It offers a low cost alternative to in-house development, and brings the transparency and visibility of risk across the organisation that is a number one priority for banks today.

For more information please contact: Hyper Rig Royal London House 22-25 Finsbury Square London EC2A 1DX info@hyperrig.net +44 (0) 203 301 6320 Numerix New York (Corporate Headquarters) Numerix LLC 150 E. 42nd St., 15th FL New York, NY 10017 sales@numerix.com Tel: +1.212.302.2220 Fax: +1.212.302.6934

www.numerix.com

Copyright 2011 Numerix LLC. All rights reserved. Numerix, the Numerix logo, and CrossAsset are either registered trademarks, or trademarks, of Numerix LLC in the United States and/or other countries.