Wall Street meltdown may drive risk-management investments

The ongoing chaos on Wall Street could hold an upside for vendors of risk-management technologies and practices, as well as sellers of compliance management products.

Analysts expect an increased interest in these products from financial companies for competitive reasons, and to comply with the new regulations that many predict are inevitable following the meltdown.

One area many agree is likely to see much greater interest is risk-modeling and financial risk management.

There are some "core tenets" for effective risk management highlighted by the current crisis, said Dave Hoag, director of clearing technology at US-based derivatives exchange the CME Group.

The biggest of them: The need for fair and transparent visibility into the models, data and analytics that go into calculating the risk associated with different financial transactions, Hoag said. Expect to see greater investment in risk management technologies as companies seek, or are driven to, implement this greater transparency in their risk calculation processes, he said.

Even though the current problems on Wall Street have more to do with an absence of regulatory oversight than with faulty risk management practices, expect to see a greater focus on accounting for risk at least for some time, said Glyn Holton, an independent financial risk management consultant.

"Financial risk management makes a wonderful scapegoat [for the current crisis]," Holton said. "This is a cycle we go through when we have losses. We trot out the back-office risk management guys. There will be some more focus on strengthening risk management, some technology will be purchased and probably monitoring will be increased."

Dennis Santiago, CEO of professional services firm Institutional Risk Analytics, said the Wall Street crisis has exposed some fundamental shortcomings in the risk modeling technologies and analytics being used currently. "We have been pretty much using the same tools now for a decade. One of the things that is clearly beginning to show itself at this stage is that the techniques that worked in the last business cycle for managing risk don't work as well anymore," Santiago said.

Looking for clarity

One example is the way risks associated with structured finance transactions are modeled, he said. Many of the statistical averaging that is applied in these models are done in "an almost blind fashion on the assumption that it has worked all this time," said Santiago. That has turned out to be a completely wrong assumption, resulting in people losing confidence in these transactions or betting against them, he said.

What's needed now is a greater investment in analytical techniques and systems that is closer to how the financial sector actually operates, Santiago said. "Ultimately you are talking about a combination of hardware, combination of software or analytical techniques and a combination of business practices and culture. The two that are the ones that are greatest need of treatment are the analytical techniques that are encoded in the software and the business practices."