Richard Bennett, European president of Razor Risk Technologies, answers SCI's questions

Q: How and when did Razor Risk Technologies become involved in the structured finance market?
A: Razor Risk Technologies is an Australian firm listed on the ASX, which has been around since 1999 - although the risk management side of the business came about in 2003. We've built up our client roster steadily since then. It now includes leading financial institutions, such as LCH, HSBC, RBC, Man Group and MF Global. They use us for anything from sophisticated risk management to straightforward limit/excess management.

Clients tend to have global implementations and we have a global reach, with three main centres in Australia, New York/Toronto and London. Our staff have technology and risk consulting/trading consulting expertise.

Q: Do you focus on a broad range of asset classes or only one?
A: The Razor product suite manages a broad range of different asset classes and includes market risk, credit risk and economic capital calculators. The service enables institutions to measure risk, manage it and gain control of it in terms of limits. Typically, the board of directors will define the risk appetite of the institution and consequently its limits.

Our software enables simulation of the evolution of a portfolio or transaction through time. The software identifies different potential future market movements and then develops appropriate risk/hedging strategies for them.

This involves capturing data of the underlying and combining it with our analytics. The aim is to help clients risk manage the exposures associated with those instruments. If a particular CMBS tranche, for example, is underwater, we can simulate it forwards to gauge how the tranche will perform under different scenarios.

A risk management implementation typically involves a discovery phase, in which we apply some risk consulting rigour and come up with a plan to address the issues that have been highlighted. This is followed by the implementation process, which includes getting everyone appropriate in the organisation to agree on the plan.

We typically speak to chief risk officers and heads of trading (or whoever looks after the portfolio), as well as discussing the plan with an organisation's IT department because it needs to fit into the organisation's infrastructure. In some cases we talk to an organisation's board of directors or senior management - this is becoming more common, as regulators and shareholders step up their scrutiny of risk management. We've always typically met with senior staff, but they're getting involved earlier in the process now.

Q: How do you differentiate yourself from your competitors?
A: Our clients tell us that what differentiates us from other risk management system providers is our ability to execute. Rather than taking 12-18 months, like some of our competitors, we typically take eight or nine months for an implementation. We even managed to get one client up and running in four weeks, but that was an exception.

If an implementation takes too long, project motivation becomes difficult to sustain.

We send staff on site to do the systems implementation and knowledge transfer, so clients don't need to call on us (though they can if they want to) and they can modify the system themselves. From time to time, we'll have a planning session with clients to discuss and execute new product initiatives or changes in risk appetite.

Another aspect of our service that clients like is our ability to add new risk methodologies over time. We spend time doing research to keep up with new methodologies; for example, our internal research or university white papers. Clients help drive this aspect too; for instance, if they have a particular view in terms of how methodologies will change going forward.

We have internal model approval by many regulatory authorities, which means that implementations have to be embedded into the institution from both a qualitative and quantitative perspective to ensure that senior management is fully involved with risk decisions. The qualitative aspect of this is how the implementation is embedded and the quantitative aspect is the mix of data and analytics that is employed.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: It has been a 'good' global financial crisis in the sense that it pulled the market into unusual situations. The upshot is that there'll be more rigour involved in risk management: market participants will have to spend more time discussing and agreeing on risk appetite and models, as well as coming up with evidence that they've done so.

Risk management is also changing and moving away from the risk model used in the last 10-15 years towards newer risk methodologies. This involves questioning the original assumptions; for example, what constitutes 'market normality'. We've begun including samples of defaults into our market risk models to move away from the 'normality' assumption.

The old way of risk management was to assume that the portfolio of today would be the same tomorrow and in the future, and that if the portfolio got into trouble, you could trade out of it in 30 days. But that assumption has been severely stressed over the last two years.

Our clients have embedded rules that adjust their portfolios through time, taking into account for example any coupons received or options being executed. This approach better reflects how a portfolio changes through time helping our clients to manage their risks with better forward-looking hedges. But many firms are still using the old static portfolio assumption, which has proved to be very dangerous.

It's interesting to note that the institutions that queried their risk model assumptions and incorporated new ideas, such as adjusting their portfolios through time, had a 'better' financial crisis than the institutions which did not question the assumptions in their risk models.

Consequently, there has been an uptick in demand for our services: we're up 40% from last year (June to June). This is being driven both by the current volatility in the market and by what has happened over the last two years. The desire to manage risk differently from how it was managed in the past is certainly increasing: when things are going well, it is easy not to worry that much about risk management.

We're busy working on a number of projects in terms of both updating methodologies and implementating new risk systems. We typically update them depending on how a client's business model changes. But, assuming a client's business remains the same, this process is usually done every year or so.

Q: What major developments do you need/expect from the market in the future?
A: Regulation is the proverbial elephant in the room. Many regulatory actions are occurring across different jurisdictions and so it will be interesting to see whether the various regulators manage to keep a level playing field across the different jurisdictions.

Equally, liquidity remains an issue and this will take time to work its way through the system. For example, we are seeing more bank recapitalisations.

It will also take time before investor appetite returns, with for example the ratings issue still needing to be resolved. One consequence of this is that investors are demanding more data in deal documentation.

In any case, it's clear that the structured finance market needs to go through a regreening process in terms of models and data.

CS