In today’s volatile post-pandemic environment, the possibility that a counterparty may default is one of the biggest risks that investment banks need to manage. This reality was underlined in April by the large losses incurred by some industry players during the collapse of Archegos Capital, totaling to around $10bn in a matter of days. Those players that were—for whatever reasons—unable to detect the signs early and then act promptly to limit their exposures were left at the mercy of cratering prices.
Given this experience, I believe that banks now need to move to the next level of counterparty risk management geared to today´s environment by leveraging real-time data and applying holistic data management to provide actionable insights for decision makers at the earliest possible stage. But how can firms get to this position? By taking three key steps that I would encourage all banks to consider.
Three steps to transform counterparty risk management
1. Establish a strong set of warning signals.
The first step is to define a set of early warning indicators that could help to identify stressed counterparties, underpinned by a clearly defined set of rules for interpreting those indicators.
While this might sound simple, it really isn´t. Because the indicators need to be defined across business lines and use the same definitions for the same context, attempting to create them raises the challenge of getting input from various stakeholder groups. The chart below shows some possible quantitative and qualitative data points that could be used. Only if these indicators are defined across the different businesses, firms would be able to identify risk holistically and, in turn, consolidate the underlying data.
Examples of common stress indicators (not exhaustive)
Click/tap to view a larger image.
2. Create a common ‘source of truth’ around data.
For Counterparty Credit Risk teams to reach an accurate assessment of counterparties’ health, it’s necessary to consolidate stress indicators as well as contextual information such as position, margin, counterparty relationship and market risk data. While most firms may probably have the required data already, the reality in many cases is that these pieces of information are available only in disaggregated ways. This means that when questions arise, identifying a stressed counterparty requires time-intensive manual effort.
The solution? By consolidating, standardizing, and automating data in a single repository, a firm can lay the groundwork for risk teams to identify and assess specific situations quickly, and then escalate their findings to various stakeholder groups as the basis for specific action.
3. Develop action plans that can be activated.
Relevant data that is collected and analyzed in real-time can help firms rapidly identify stressed counterparties. Having done this, the next step is to respond appropriately using predefined workflows to implement comprehensive action plans. These front-to-back business processes need to ensure that signs of a stressed counterparty—such as the breaching of thresholds across various stress indicators—and the additional contextual information are escalated to the relevant teams in areas like Risk and Sales and Trading, enabling these business groups to act swiftly if needed. Depending on the severity of the situation, decision points may be required with senior stakeholders to decide on appropriate actions in a very short timeframe.
Making these action plans as effective as possible also requires something else: the adoption of an organization-wide culture that embraces active risk management. So, change management is a key part of the journey when implementing the risk management practices and tools described above.
It’s not only about data and technology-but also processes and culture
The message is clear. By leveraging relevant real-time data and contextual information in a holistic way, investment banks can reinvent their counterparty risk management for the post-pandemic world. But doing this successfully requires more than enhancements to data and technology: also needed are actions focused on front-to-back business processes and appropriate culture change. If you’d like to hear more on this topic or discuss it in further detail, please feel free to reach out to me directly or leave a comment under this blog.