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Geopolitics, volatility, and transformation are top concerns for trading and intraday risk management

Experts discussed how they are dealing with unprecedented global events and their impact on volatility.

Geopolitical and exogenous events have joined market risk as challenges that make trading and risk management difficult. But traders, data analysts and portfolio managers have no choice but to develop and employ tools and judgement to ride out the volatility. A webinar discussion held by ICE and Asia Risk – titled “Trading and intraday risk management amid market dislocation” – focused on how participants in different sectors are confronting today’s unusual challenges.

Geopolitical risks

Kicking things off was a poll of the webinar’s viewers, who were especially concerned about geopolitical risks in today’s market, putting it in the top spot of worries ahead of market volatility, inflation, and operational risks. Panellists echoed this sentiment and offered explanations about how to handle today’s unprecedented volatility.

Leo Tay, managing director & head of FX, rates, and derivatives trading, ING Bank, remarked that he was not surprised that geopolitical risk is high on everyone’s list of concerns. He further commented that it is particularly difficult to model. Time series cannot model it because it is regarded as tail end risk event- difficult to predict because it is subject to a human element.

It was also clear to the panel that geopolitical risk is also challenging to predict because of the nuances of tail risk. David Ng, chief operating officer, CSOP Asset Management Ltd said, that as a buy side, ETF issuer and passive index tracker this kind of volatility is nothing they haven’t seen before. He commented that “I think we are a little more cognizant of the liquidity we see in the market. Sometimes, due to extreme volatility, we might see widening a bit of spreads or liquidity drying up.” For product development, Ng stated he saw opportunities such as capturing trends and launching inflation themed products from this macroeconomic environment.

Dr. Xiao Xiao, head of derivatives and regulation, APAC, ICE Data Services observed, “If we look at 2022, it’s definitely complicated. We have seen a convergence of previously unprecedented events. When you put them together, it’s a perfect storm with Industries and individuals impacted as we speak.” She further indicated that inflation is causing high prices driven by high fuel and energy prices, and supply chain stress. Monetary policy is tightening growth prospects. This increases the amount and nature of market volatility. Yet, there is a silver lining in trading strategies and opportunities. Clients are interested in new trading data sets so they can identify opportunities and develop innovative strategies.

Later in the webinar, when asked by the webinar’s viewers how geopolitical risk was impacting different products in unique ways, the panel responded by explaining how nuanced differences in intraday risk management occur more in asset classes rather than in products. Ng laid out the situation saying, “Fixed income, geopolitical risk, supply chain issues, and we see supply-side inflation hitting rates being raised by the Fed. This, obviously, will have a trickle down effect into fixed income or rates products. But the risk we see in equities requires different risk management.” He went on to say how nuances due to geographies, such as between US and Asia, occur in terms of liquidity pools and market structure affecting spreads. Decoupling of Asia from US and EU economies also affects various asset classes differently.

Tay pointed out that the forex market is more digitised and algorithm-based than others. He expanded saying, “When I look at FX rates and derivatives, the FX market trades a lot more on a tick basis. It’s a lot more digitised, trading is a lot more electronic, a lot more algos drive this space, so in terms of intraday risk management from a sales side perspective you’ve got to make sure that your algorithms work during these volatile times.” He said that while, in theory, they follow certain rules under normal market conditions, during extreme volatility you want a pause button, human traders to step in, and the ability to fill orders.

Tay added that other markets – such as rates in Asia – aren’t fully electronic, so trading is still based on voice. He said, “Different dynamics occur on rates products. If you look some Asian markets, they aren’t fully electronic yet. There’s a lot of voice trading involved and some markets which are predominantly voice traded, both on FX and rate side. So, depending on the products you manage, there will be differences in how to manage and measure those intraday risks.”

Xiao opined, Geopolitical risk is something that wrecks everyone’s nerves, one thinks of how it affects different asset classes…and it’s also impacting how the firms are viewing risk management as a tool. She provided the example of how the views of private banks on risk management interact with their clients’ concerns. Private banks see the significance of having intraday margin calculations on their clients’ portfolios as well as other real time risk measures.

Volatility and Liquidity

Current market conditions are impacting the buy side in risk managed portfolios. The panel had to consider what the key concerns and management techniques were for real time, intraday traded risk management, advanced liquidity risk and best execution.

Ng voiced his belief that under volatility, liquidity risk management is the top priority for buy side houses. He said, “Volatility obviously introduces liquidity risk. From a liquidity management perspective, we have been looking at advanced liquidity management especially in the pre-trade portion of it. Especially in the markets where we trade in Asia, markets are not so homogeneous. Some of our products listed in Hong Kong which hosts both Hong Kong and China equities, market factors are different across both onshore and offshore.”

Ng added that actors like average volume, average days-to-trade all enter analysis. He said, “We watch for less liquid names or potential names that we may not be able to fill. And these will all contribute in terms of us as a passive house into tracking differences for our products against the index we’re tracking. So, this is a risk we are very keen to avoid. And for Asian markets, traditional parametric factors that we consider in terms of pre-trade analysis is usually insufficient when you think about some of the different market structures you have to deal with.” He cited how onshore restrictions create different liquidity profiles and that liquidity planning has become more quantitative in the pre-planning phase in these times.

Xiao also highlighted that Real-time/Intraday management is an effective way to identify, assess and monitor the impact of volatilities. Speaking on best execution analytics, Xiao voiced that it’s something that ICE have seen leveraged more in trading than before. ICE’s best execution information services help clients meet regulatory compliance to support the compliance office to closely monitor firm’s trading activities post-trade. Today, it has expanded as traders/clients assess best execution and trading effectiveness at the pre-trade stage. It offers a positive feedback loop to improve their trading setup. “

Digital Transformation

Trading in the general aftermath of COVID is still riding a massive wave of digital transformation and huge investment in new technology. A trend the panel looked upon favourably.

Tay commented that during COVID, ING Bank had leveraged technology as much as possible. He stated that intraday risk was managed through optimised techniques. These are applicable today even with current intraday volatility. Core aspects of risk management require using internal and external data to optimise the tools.

Tay expanded, “Data availability depends on the products you trade. Some of the parts that are much more commoditised, like FX for example, you do get very nice clean data out of them and you can use those for your data analytics. Especially with market dislocation, it becomes increasingly important that you do get the correct dataset for you to use in your risk management.”

Xiao stated her belief that there is more need for intraday risk management tools and data. She said, “This is a huge value add in terms of us moving towards intraday or real time risk management.” Xiao was also keen to point out the massive advances in storage and transfer technology that are making data availability increasingly limitless.

Ng concurred that data availability is the future, saying, “Data availability is predicated on two things. One, is obviously cost; data is the new oil of the future. The other is the infrastructure that allows us to tap into that data. The data technology we have, whether it be it on a cloud, will allows us to process large amounts of data in quick time. But all these things come at a cost.” He also commented that the volatility experienced today is unprecedented and the call for timely risk management requires more time and resources for data processing.

When considering how advanced data analytics were impacting risk management and trading activities, the panel championed the ability to better respond to situations outside of the norm.

Xiao stated, “Using stress testing with different, extreme scenarios one could gain insight into how the portfolio behaves during those scenarios…The more advanced the analytics, the greater the firm’s ability to react to eventualities. For me, data analytics allows you to translate data into actionable insight.”

Ng added that data analytics was important in pre-trading analysis issues like duration, volatility and studying data points where differences in market structures create wide differences in bid-ask spreads and liquidity is thin. He believed they need to be analysed on a platform as they affect competitive strategy.

Discussion turned to if advanced analytics would be able to reduce the risk presented by any future repeats of crises like the Archegos Capital Management collapse. In response, the panel referred to how Credit Suisse had since demonstrated the importance of using advanced analytics to make more informed counterparty decisions regarding dynamic margins and that a robust risk framework coupled with advanced analytics would help guide decisions.

Commenting on how technology could help during times of turmoil, Xiao said, “You do need to have a good risk framework to start, and then you have the data analytics as a tool to guide you and support all of the decision making.”

There was more of a mixed reaction from the panel towards another innovation, AI adoption. Even if there was agreement that investment management and trading would be increasingly driven by machines, it was voiced that human beings should remain at the helm for the foreseeable future.

Tay said, “A lot of the geopolitical risks, the concerns that we have, is just very difficult to model. I’m not sure, but I suppose AI will be able to help us with some of those modelling issues and help us with better judgements and decision making.”

When viewers of the webinar were asked what key investments were required for real time/intraday risk management, they said they were most concerned about data availability, analytics capability, and risk management frameworks, in that order.

Panel discussion

Trading and intraday risk management amid market dislocation