It is safe to say I am passionate about risk management. I started my career in risk management and I have built a company around risk management. There is much more behind the scenes than A book and B book.
The foundation for managing risk properly is making sure a proper technology infrastructure is in place. With the right technology in place, a risk team can focus on every day operations and book optimization. I have seen far too many examples of good teams using bad technology. Without a doubt, this leads to trouble for the broker and for the clients.
Once the infrastructure is sound, a risk team should be focusing on protecting the firm and making sure clients have a fair trading environment. The first thing a team should do is establish some ground rules. Book optimization is fluid and must never be neglected, but management should have guidelines for equity and position size they are comfortable with. An important factor to consider for the guidelines is the size of the firm’s balance sheet.
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The next step is to establish effective real time trade flow monitoring. Toxic flow can have a disastrous effect on a broker. One bad rate and the “arb bots” go on a feeding frenzy. If accounts are able to get away with toxic behavior, there is a snowball effect because brokers get huge targets on their back. Toxic accounts are always looking for an edge and a risk management team needs to always be on guard.
Another very important aspect of risk management is working with sales so they can write effective deals. IB’s are looking for the best possible deal and their demands are getting more extreme each day. It is very important to have a seamless bridge between sales and risk management so deals can be written to not only win business, but also to protect the firm.
Additionally, every team needs a reporting guru. There is no off the shelf solution that will be deep enough for the lengths a risk management team needs to go in order to be effective. Risk managers need to have excellent database querying skills as well as business intellect. There are more brokers than there is talent in this arena which presents a huge challenge. If you have someone like this on your team, treat them well.
Risk management is an evolving field and there are many moving pieces. The team needs to be fluid and dynamic. At the end of the day, volume does not equal revenue, so manage your risks properly.