Dan Rosen, ceo and co-founder, and Benoit Fleury, head of financial engineering and products at R² Financial Technologies, answer SCI's questions

Q: How and when did R² Financial Technologies become involved in the structured credit market?
A: We started in this business by conducting groundbreaking research on how to price complex credit derivatives and structured finance assets for one of the largest structurers on Wall Street. That engagement helped us gain a deep understanding of the analytical and infrastructural requirements for large sell-side clients that need to price and risk-profile thousands of structured finance and credit derivative deals on a near real-time basis.

Our main conclusion was that the buy-side would soon need the same level of analytical sophistication, but that the software to do so didn't exist - it needed to be engineered from the outset to handle complex credit products, but it also needed to be packaged, easy-to-deploy and much cheaper to maintain. So in 2006, we began development of NxR2, a front-office portfolio construction and risk management solution, and Dan Rosen                                                         R² Credit Capital, a middle-office economic capital management platform.

I think it's a credit to the people we have working for us, and the fit of the solutions they build, that we have achieved such broad commercial success during these tough economic times. We now have clients in North America, Europe, Asia and the Middle- East that include hedge funds, banks, asset managers, investment banks, structurers and regulators.

Q: Do you focus on a broad range of asset classes or only one?
A: R² software applications are designed to perform sophisticated quantitative analysis of credit portfolios in real-time. We cover all credit products, including structured finance assets (ABS, MBS, CMBS, CLOs, CDOs), credit derivatives, credit indices, synthetic CDOs, fixed income, derivatives and equities.

Q: What's your release cycle like?
A: We upgrade our software products every six weeks and automatically migrate all of our clients to the latest version of the software. We're a young, dynamic software firm, so it's important for us to spend time with clients to understand their business needs and ensure that this feedback loops back into our offerings in a timely manner.

Q: What are you working on at the moment?
A: We're working on:

1. Extensions to NAV reporting framework for CLO investors
2. Extensions to simulation capabilities for CMBS investors
Benoit Fleury                                                     3. Integration of additional data sources (Loan Performance, ABSXchange)
4. Extensions to our Monte Carlo pricing and risk profiling capabilities for all structured finance assets. This includes a powerful calibration module
5. Enhancements to our performance attribution module
6. Incorporation of analytics to measure capital requirements for structured finance assets.

On the capital side, we continue to expand our counterparty credit risk profiling capabilities and measurement of incremental risk charge (IRC). The idea is to aggregate counterparty exposures to create a complete picture of a portfolio and the value of its credit risk, as well as how to apportion the exposure across the portfolio. This is being driven by internal requirements to create a more granular picture of which counterparty is contributing to which netting or margining requirement.

We are expecting significant demand for this product as the implementation of the Basel 2 rules gathers momentum. It will initially be applied in the middle office and then probably migrate to the front office.

Q: How do you differentiate yourself from your competitors?
A: What's unique about us is that:

1. Other vendors specialise in certain products, whereas we cover all credit products. But, significantly, we do so at the level of granularity expected by portfolio managers and traders.
2. Most vendors look at one deal at a time; we focus on the portfolio view. We offer sophisticated data management tools to help price and risk-profile large portfolios of securities in a consistent and secure manner.
3. We have superior analytics. For instance, we built Monte-Carlo pricing functions for structured finance assets where baseline default, prepayment, severity and correlation assumptions can be set at the loan, cluster or deal levels. But in the end, MC reports are only useful if they can be employed in the real world. This is why we calibrate our models to observable market prices and distribute the simulations across a computer grid so you get the results back quickly, often in real-time.
4. We are not promoting a given data vendor over another; in fact, we integrate them all. Our clients want us to mix and match data from different sources directly into their analysis. R² makes it easy for them to do so through our generic data loaders and our data cleansing and reconciliation layer.
5. We deliver sophisticated quantitative analysis in an intuitive way. We are all about "advanced analytics, but simple solutions".
6. We deliver business tools, not a software system. Our solution offers specialised business reports to help screen potential investment opportunities, mark portfolios, measure risk, measure performance and control unwanted exposure.
7. We use state-of-the-art technology. We built our products from the ground up using the most recent technology stack. This provides us with greater flexibility, which enables us to deliver more capabilities, faster.

Most importantly, we target some of the industry's most difficult problems, such as:

• How to accurately measure risk in real-time?
• How to run meaningful pre-deal analysis?
• How to mark large portfolios of complex products in an accurate and consistent manner?
• How to measure performance and attribute it to meaningful investment decisions and market movements?
• How to measure and allocate capital consumptions from an economic and regulatory standpoint?
• How to aggregate market, credit and operational risk in a consistent and transparent manner?
• How to effectively communicate investment ideas and decisions to senior management and to external investors?
• How to implement a disciplined, fact-based, risk management culture that empowers portfolio managers?

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: Before the crisis, there was not enough questioning regarding the quality of the models employed, nor around the underlying assumptions made. In fact, many of the models employed were not appropriate, or they weren't applied or calibrated properly.

Few managers understood how sensitive the analytics produced were to the different assumptions made. There was also an overreliance on biased third-party valuations and rating estimates.

Ratings are fine to analyse corporate credits, but they cannot be used to measure risk in a dynamic securitisation structure. A vivid illustration of this is the amount of rating arbitrage done on structured finance deals prior to the crisis.

The crisis, for all its pain, has crystallised the need to analyse deals at a much more granular level, to employ better models that are better calibrated and linked to appropriate data sources. We think this represents a great opportunity for us to implicate and educate portfolio managers and senior managers on the importance of participating in the firm's valuation and risk measurement processes.

Senior managers are increasingly becoming involved in the valuation process and so need to understand the amount of risk associated with the sometimes "heroic" assumptions made in the valuation process. They are also increasingly aware of the need to understand how liquidity may impact their valuation or risk estimates.

We firmly believe that valuation platforms are a key tool with which to attract and retain investor capital. Investors want a more detailed view of risk and liquidity - long gone are the days when investors put money into a fund without asking any questions. A robust valuation tool enables clients to explain to their investors, in a granular, transparent way, how they're creating value and what the key risk drivers and sources of returns are. That's how we've approached the design and development of our products.

Q: What major developments do you need/expect from the market in the future?
A: Our view is that 2010 is a transition year where some markets (e.g. CDOs) will still suffer, while others will start to re-emerge slowly (e.g. CLO, CMBS). In terms of the regulatory reaction, I think the pendulum has swung a little too far.

We believe that credit and securitisation are fundamental to the health of the economy. We're unlikely to return to the originate-to-distribute model, but there are more efficient ways of doing this than severe regulation.

We think 2011 will be a good year for structured finance investors. Having the ability to independently price and risk-profile deals and portfolios will quickly become a mandatory component of a firm's investment process and will be key to its ability to attract funds. So we're gearing up heavily in anticipation of this and are very excited about the opportunities it will bring.