Rohan Douglas, ceo of Quantifi, answers SCI's questions

Q: How and when did Quantifi become involved in the structured credit market?
A: I set Quantifi up in 2002, having previously run the global credit derivative research group at Citi. I saw an opportunity at that time in an environment where the biggest banks had sophisticated internal risk management and pricing systems, but new entrants to the credit market lacked access to such infrastructure. The timing was fortuitous as it allowed us to participate in the subsequent growth of the market.

For our first two years of operation, we worked with a single client to build out our suite of products and then expanded to a broader range of clients. We now have over 120 clients, split fairly evenly between the buy- and sell-side.

Quantifi provides a range of integrated pre-trade and post-trade analysis, pricing, structuring and risk management solutions.

Q: Do you focus on a broad range of asset classes or only one?
A: We aim to be the leading analytics and risk management provider in the broader credit markets. We specialise in cash and synthetic credit products, including sovereign and corporate bonds, loans, CDS, nth-to-default baskets and synthetic CDOs, CLOs, convertibles and interest rate derivatives.

One interesting project we're focusing on at the moment is the area of counterparty credit risk. This follows our recent acquisition of Moment Analytics (see SCI issue 161), whose ceo David Kelly formerly managed counterparty credit risk for Citi.

Counterparty risk touches on a number of asset classes and plays directly to our credit modelling expertise and technology infrastructure: the ability to create fast ad-hoc scenarios is a primary focus for large financial institutions right now. They need to be able to run large-scale Monte Carlo analyses across portfolios.

Because the work is computationally intensive, it is important to be timely. There is a gap in the market for this kind of capability.

The acquisition of Moment Analytics brings a great deal of value to Quantifi and, in particular, David's expertise in counterparty risk will be an important part of our development in this area.

Q: How do you differentiate yourself from your competitors?
A: One differentiating factor is that our technology infrastructure was built from the ground up. Whereas other vendors may offer, for example, add-on scenario analysis functions, we can produce faster results because it has always been an integral part of the risk engine. Equally, our analytics library was built on a .Net platform, so performance has always been a key element of the product.

Another differentiator is that we bring on board experienced people from the industry, so we better understand the nature of our clients' needs. Our infrastructure means we can respond to those needs rapidly; as a result, we've been first to market with a number of products. I think this flexibility will be important in 2010.

Finally, while many vendors are geared towards serving banks, the strength of our risk management system is its scalability. For smaller market participants, we can roll it out in a matter of weeks.

Q: What has been the most significant development in the credit market in recent years?
A: In 2009, the most significant development in the credit market was the introduction of standardised CDS contracts: the downstream effects of this are still being played out. Standardised contracts have changed how risk analysis and processing of credit derivatives are viewed. Essentially, financial institutions have not yet implemented the necessary systems for more detailed analysis.

Certainly the challenge for some institutions is that credit products evolve at a pace that not all existing systems are geared up for. The simplest credit product can be fitted into an interest rate swap system, but more complicated structures need more sophisticated systems.

We've been a believer for a long time in the benefits of the credit markets: it's natural for the market to see a transition in investors from investment banks to broader market participants. The evolution of CDS has followed a similar path to interest rate swaps: most large corporate treasurers use interest rate swaps and some use CDS - this usage will only increase going forward. Although the credit crisis has delayed such broader adoption for a while, the infrastructure changes in the pipeline - if structured correctly - will only accelerate this trend; for example, through better transparency and automation.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The challenges affecting the OTC derivatives and credit markets more broadly are creating opportunities for Quantifi. In particular, the credit crisis demonstrated that, in certain cases, older legacy risk management models didn't perform as needed or expected. In addition, regulatory changes are having a structural effect on the market.

The overall impact of these challenges will remain uncertain until the final regulatory picture is resolved. However, institutions are already readjusting their priorities in expectation of the need for greater reporting.

The general direction and focus of regulatory efforts is clear: the intention is to introduce CCPs and begin clearing a growing area of the OTC market, as well as increase regulatory reporting. The market is heading in the right direction with regulation, but the slightest change in focus further down the line can have a huge impact. The more complex the regulation, the more likely it is that unintended consequences could occur.

Historically, the CDS market has been dominated by big banks, and it is hard to predict how the opening of the market to new participants will impact the landscape. The concern for some on the buy-side is that the regulatory changes will increase the cost of trading CDS, but I'm not so convinced about this argument. The tying together of all the different pieces involved in using a CCP will be a challenge for most players, especially in an environment where there are cost constraints.

The CDS market has traditionally been quite competitive, with aggressive bid/offer spreads and plenty of liquidity. I'm not sure what the net effect will be if banks are no longer so motivated to provide liquidity. However, if you look at the development of other derivative asset classes, there is a good case to be made around the positive benefits of clearing in terms of liquidity and market size.

Q: What major developments do you need/expect from the market in the future?
A: We talk to many different institutions and there appears to still be wide variety in risk management practices - albeit the average level of sophistication and awareness of industry best-practice has gone up a notch. The experience we've had is that, during times of volatility, firms that don't have the necessary infrastructure end up having difficulties.

There is still work to be done: fundamental changes are taking place in the OTC derivatives trading and processing space that will have a profound impact on infrastructure, but not everyone has bought into this and many are still not prepared. In terms of the independent valuations space, for example, more market participants need to be aware of the benefits of scenario-based analysis.

Traditional static risk management approaches are based on individual sensitivities; thus the danger is that users assume everything stays the same. VaR, another common analysis, involves simplified assumptions about the distribution of market moves. But both approaches miss key elements of risks in more complex markets.

Scenario-based analysis involves analysing specific examples: cases that will realistically capture events that could/have happened to identify the relationships between different moving parts of the market. It also provides the ability to consider arbitrary scenarios on an ad-hoc basis.

CS