Risk - constantly shifting sands

The world has changed since COVID-19, that much is obvious and is an oft-repeated truism. The trading landscape alters daily, with new challenges, opportunities and risks presenting themselves in a multitude of regions as public health and economic factors play themselves out. Trading firms have never had to react and adjust so quickly, and building this volatility into long term trading strategies is no mean feat. Indeed, the risks presented by such rapid change are a far higher threat than those that - in the old world - were more predictable and slower-moving, and risk management practices must be adjusted to cope.

It’s gradually becoming clear that change is permanent - the days of predictable, known risks are arguably in the past.

It’s gradually becoming clear that this change is permanent - the days of predictable, known risks are arguably in the past. The trading landscape is now more greatly affected by global events, which themselves are more unpredictable. Good news (such as the US election, for example) and bad news both encourage a larger swing in trading activity than they otherwise would have, placing pressure on both portfolios and infrastructure. There is also some evidence that, with increasing retail participation, Twitter is becoming a source of wild stock movement. This pressure is then compounded by a distributed workforce with varying levels of infrastructural security and stability.

This unpredictability means that it’s less likely that pre-defined risk rules will be applicable to everything that happens - we just don’t know the effects that events will have on the market. Indeed, it may well be a question of who can react the quickest rather than the ability to see into the future, although the increasing use of alternative sources of data may well help divine the direction of the markets.

The ability to react quickly - risk agility perhaps - hinges on the ability of risk management systems to translate the risk assessment into rules and criteria. When markets are, relatively speaking, predictable rules can be set and adjusted infrequently but in a constantly evolving landscape, rules and criteria need to be adjusted constantly and often on the fly. Adjustment usually involves sending a request to either internal or external tech teams that then have to code a solution, often taking an unreasonable amount of time, and this is not good enough for today’s fluctuating markets. Further, being able to integrate the alternative data sources mentioned above is not as straightforward a task as it first appears. Some risk management tools integrated into trading platforms do not offer this capability, neither do they offer the ability to dynamically change or create rules.

There is a new dynamic at play in financial markets. They are delicately balanced and that balance can easily be upset and it is essential that risk management platforms are able to cope. They need to effectively monitor risk in real time and offer the ability to dynamically create rules around not only the structure of the trading book but also external data. It’s this ability to pivot on-the-fly, using all the available information, that will enable firms to successfully navigate turbulent waters that may be ahead.