Traditional risk management software vendors prepare for pay-as-you-go Internet-delivered risk management.

By Barclay T. Leib

The Internet has changed the way many derivatives products are traded. But its effect on risk management hasn't been nearly as profound—at least not yet.

There's no doubt that application service providers will change the way the buy-side and sell-side manage their risk. The only questions are, Who will emerge as the best providers of such services and when? Already, large vendors such as SunGard Trading and Risk Systems, Imagine Software, Algorithmics, Summit Systems, and FNX Ltd. are busy building Internet delivery systems for at least part of their traditional software capabilities. Meanwhile, smaller vendors and new startups are threatening to steal market share by delivering trading and risk management systems—in some cases fully Java-based—for a fraction of the old timers' big-ticket prices.

What does that mean for clients? Historically, high-end front-to-back-office systems have been geared toward large multinational banks and big corporates. These often sport million-dollar price tags, take six months or longer to install, and can be difficult to modify or update when necessary. The largest multinationals will still need a combination of their existing client-server systems and internet-based technology.

But if everything goes as planned, ASPs will dramatically change the technology landscape, putting the entire risk management market for corporates, pension funds and hedge funds up for grabs.

Yes, most will choose to hold onto their bulky systems until ASPs have proven themselves. And there will almost certainly be some that will want to keep mission-critical data residing on internal servers. But it's clear that ASPs will eventually be able to provide front-, middle- and back-office functionality in a far more nimble fashion than the client-server model, obviating the need for expensive in-house servers and extensive IT staff. Perhaps most important, pricing will be based on a "per-user, per-month” or "per-user, per-portfolio-size” basis, rather than on huge up-front fees—making it far easier for customers to try out several different products without committing to massive licensing agreements. All of this should save companies money—and allow sophisticated risk management and other functionality to filter down the food chain to smaller players.

Conceptually, the attractiveness of Internet-delivered risk management is clear. But in practice, it's quite difficult for software vendors to migrate from a traditional client-server platform to an Internet-delivered product. For example, if an application is written in C++ language—the basic and most common software language of the last decade—the software provider faces a dilemma. Should it scrap all that code and start writing anew in more complex, Internet-based software script like Java? And, if not, how will it guarantee the look, the feel and, most critically, the response time of its platform for attracting and maintaining clients?

One approach is simply to distribute traditional client-server systems over the Internet. Many firms, like Summit Systems, are opting to use Citrix Metaframe-type terminal emulation packages, which essentially deliver already-written software programs from off-site host servers to universally accessible Internet browsers.

But is such a solution really scalable for thousands of users, extensible enough to include web-based content from other sources, and flexible enough for a company to embrace with enthusiasm? Or is this just a stopgap method to get something up on the web sooner rather than later? Many web-programmers think Citrix solutions are simply not good enough. Clients can't necessarily interact with each other all that easily, and response time from a central server may be an issue when running risk reports on large portfolios. That's why other vendors, including Imagine and FinTech, have rewritten their code, virtually from scratch, primarily using Java.

Many web-programmers think Citrix solutions are simply not good enough. Clients can't necessarily interact with each other all that easily, and response time may be an issue when running risk reports on large portfolios.

With these questions and issues in mind, we visited some of the behemoths of the risk management software world as well as some promising web-based vendors, to find out just what constitutes the state of the art in Internet-delivered risk management these days—and how much it costs. In our December issue, we'll publish a complete directory of ASPs in the derivatives trading and risk management arenas.

Of those we talked to, only two trading and risk management ASPs are actually up and running—Imagine Software and Theoretics. The others are still in beta testing, with launches promised anywhere from first quarter next year to vague dates in the future. Every company we surveyed seems to be taking a different approach, using differing technology, and forming different hosting and data partnerships. Few care to discuss that all-important question of price because of pending announcements and joint-venture non-disclosure agreements. We did, however, manage to wade through much of the typical obfuscation. Here's what we found.

FNX

Derivatives tracking software vendor FNX has been busily developing a trading and risk management ASP for full roll out in the first quarter of 2001. "We're big fans of the ASP, and think within five years practically all software will be delivered via ASP,” says Simon Moss, the firm's president. " It stands to become an absolute revolution.”

"Straight-through processing is like teenage sex. Everyone is talking about it, few actually do it, and those who do it, do it very badly. We hope to change all that.” —Simon Moss, president, FNX

While FNX's traditional client-server Sierra software package handles derivatives on a variety of capital-market products from foreign exchange to fixed income, FNX appears to be furthest along converting the foreign exchange modules of its Sierra System to an ASP-delivered product. Named Sierra ASP, this new platform is quite sophisticated with Java-based front end components, real time Java Message Servicing and Remote Method Indication links with https firewall tunneling and T3 internal messaging. The system provides sophisticated access to the full range of Sierra System functionality in a browser based, portal-like environment. Orders are handled using a web-order retrieval manager that encrypts orders and then punches them out over the web.

The million-dollar question: does the Sierra ASP offer straight-through processing? Moss certainly promises as much. "Straight-through processing is like teenage sex,” he says. "Everyone is talking about it, few actually do it, and those who do it, do it very badly. We hope to change all that.” But while FNX claims that the Sierra ASP offers full-fledged STP, the vendor stops short of using 100 percent Java-based programming. Its hybrid approach relies on Sierra's traditional C++ architecture—and Moss is unapologetic. "Many of our clients have been running our traditional Sierra System for years,” he points out. "It's not the greatest technology in the world, but it gets the job done. If FNX were to approach a global, high volume financial institution with a full Java-based back-office offering, we'd likely be laughed out of the building.”

By combining FNX's traditional Sierra System with newer web-based technologies, Moss hopes to use an extremely powerful distribution channel while ensuring FNX's software evolution on a solid foundation. "These newer technologies are not proven enough for mission-critical, high-volume work-flow environments—at least not yet,” he claims. "However, by seamlessly combining our past STP capability with these new, very powerful distribution channels we are using the best of both worlds.”

So while FNX and others are still working out the kinks with Internet-based STP, Moss sees most big banks staying with their proven traditional platforms-at least for now. But he's betting the Sierra ASP will open up a new market for his products with regional banks and corporate treasuries, attracted by a new subscription-pricing model. "We've gone from a few hundred banks to several thousand potential customers,” he says. "And while we may slowly cannibalize our traditional business by shifting to an ASP model, we're working to make sure this cannibalization protects the integrity of our client base whilst turning us into a stronger, broader company.” FNX has other product lines besides foreign exchange in ASP development, but these web-offerings aren't quite as far along.

Imagine Software

Earlier this year, when all the other big firms were just beginning to talk about their upcoming ASP offerings, Imagine Software was already selling an industrial-strength version of its trading and risk management system.

The company was formed in 1993 by former Salomon Brothers employees and it has installed its front-through-back-office product in numerous global banks. The company's Derivatives.com site offers a suite of portfolio analytics with a nice front-office look and feel—and with full middle- and back-office functionality as well.

When we tested the product, the risk analytics and real-time data feed were impressive, and the system quickly crunched out a risk report on a 40-position portfolio. Even better, the system saves its historical mark-to-market information, including implied volatility levels and volatility skews, and can display this information easily for review in tabular or graphical form—a nice resource for traders.

The offering, more than just a collection of features, includes a number of value-added services. The most useful is a fully maintained Security Master, a huge database of equity securities and benchmark bonds. Without Imagine doing the work, porfolio managers would have to adjust the value of their options manually every time a stock splits or a company merged or changed its name.

Dividends are another headache that Imagine manages. Using a dividend yield isn't sufficient to give you the fair value of an option, the company argues, because your expiry could fall before or after IBM actually pays out. The firm also updates a full volatility surface, derived from liquid options markets. With illiquid options, the default is historical.

Although the system is strongest in equities, it supports all the major fixed-income and currency derivatives, including interest rate and currency swaps forwards and options. Bond volatility products such as caps, floors and options are promised in the first quarter of next year.

Imagine's goal is to offer a full-blown system that nevertheless affordable for smaller hedge funds and corporates. The company says it is still refining its pricing policies for Derivatives.com, but early indications are that a $3,000 to $10,000 price tag per user, per month is likely. If you're a long/short equity hedge fund manager who just hired a bunch of options traders, that kind of price tag may be appealing.

Summit Systems

In the fixed-income arena, the ASP from vendor Summit Systems seems to be the furthest along, although the potential price tag and real-time response time of this offering remain question marks.

The product, called SummitTransact.com, has the same look and feel of Summit's traditional client-server software package, and is delivered over the Internet using Citrix technology from a Global Center hosting facility in New York that's already up and running. ASP project manager Thomas Hans hopes that Citrix's ability to reallocate load capacity automatically between servers will make their application's response time acceptable to users, but the company is still conducting capacity testing and recommends a minimum 256K connection. In short, don't expect this ASP to breeze along when accessed by a telephone modem from home.

Summit, like others, hopes to lower customers' IT infrastructure costs by allowing them to choose only the modules they need by subscription service. But their offering is still high-end in its overall functionality. The ASP offers such perks as a real-time credit server and an application server that continually queries the database and delivers automatic refreshes every few seconds. Reports can be configured by individual users in numerous ways, and the company expects to be offering straight-through exception-processing on Summit in less than six months for various high-volume businesses.

Summit's ASP is quite extensive, offering virtually all the functionality of the Summit System. But price, response time and front-office user-friendliness may still be the potential stumbling blocks. Summit has also yet to design tailored screen configurations for the new vertical market niches that the system is presumably intended to service—corporates and hedge funds.

For instance, although Summit has a nifty report that allows P&L to be broken down and attributed to different factors such as delta, theta, rho and new trading, the company has yet to offer reports specifically geared to FAS 133 compliance. Nor has Summit added any specific reports for hedge fund accounting, although the system's ability to slice and dice a portfolio by any number of filters might make this easy to accomplish. "Added functionality for hedge funds is on the agenda,” says Hans.

Algorithmics

Algorithmics is a risk management software company with few solo projects to demonstrate in the ASP space. But it has big plans. So big, in fact, that the firm has entered into a joint venture with Bridge Information Systems called AlgoSource to bring its ASP vision to a wider marketplace.

We want to be the risk analysis engine for the on-line financial portals of the world. —Gordon Yeager, president, AlgoSource

According to Gordon Yeager, who heads AlgoSource, the company will be an enabler of ASPs rather than an ASP itself, providing its risk-enhanced Mark-to-Future data and technology to others. Eventually, Yeager hopes, "Algo Inside” will become as well-recognized in the derivatives world as "Intel Inside.”

Already, Algo's technology powers ASP risk-analysis providers such as Credit Suisse First Boston's PrimeRisk and Measurisk.com. "Just as 90 percent of financial web sites create their charting analytics using technology from Bigcharts.com,” says Yeager, "AlgoSource wants 90 percent of the risk modules of major on-line brokerage firms, financial advisers and money managers to be driven by an AlgoSource solution. We want to be the risk analysis engine for the on-line financial portals of the world.”

Mark-to-Future is attractive to end-users and ASPs because it decouples the computationally intensive simulation stage from calculating portfolio risk measures on actual trading positions. "We start with a security's description and different models to mark something to market now,” explains Yeager. "Then we move forward in time and apply thousands of different scenarios to each security—movements in underlying risk factors, probabilistic sets of scenarios, one-off scenarios, historic scenarios. This creates what we call our ‘Mark-to-Future Cube.' All of this is done at the security level, not at the position level, so it is very scalable to any portfolio.” As a final step, AlgoSource applies position sizes to its Mark-to-Future results in a post-processing-stage. Because Mark-to-Future models instruments and not portfolios, asset values only need to be calculated once and not separately for each investor's portfolio. This is a natural fit for the ASP world.

Ultimately, Yeager hopes, AlgoSource will deliver various tools for individual investors that will help them visualize the potential impact of everyday market developments better. "All of this should be very valuable to financial advisers—a real productivity tool,” he notes. "Advisers can take a given event or piece of research and quickly determine to whom it pertains the most. Suddenly, our risk report could become a call list, and e-mail and cellular alerts can be sent out.”

Wall Street Systems

While many big vendors are concentrating on bringing sophisticated risk management to the masses, Wall Street Systems would be happy, in the next few months to conquer a more modest hurdle: bringing proper FAS 133 derivatives compliance to the corporate world. A more ambitious multi-module ASP would then follow.

"We're aiming this at companies that don't have a system at all, or don't have a FAS-compliant system, and need a way of valuing their exposure and generating the accounting entries that come out of this.” —Keith Bergman, ASP product manager, Wall Street Systems

WSS has spent the last two years working to web-enable their entire core product, but first off the shelf is a stand-alone Java-based platform—still unnamed—with a suite of utilities and analytical tools to process and mark-to-market derivative hedges to comply with FAS 133. Specifically, the system will allow users to package and document at inception all hedging relationships and test for hedge effectiveness both in the present and retrospectively. The system has the ability to split out the change in value of a derivatives hedge between its intrinsic-value portion and its time-decay portion, and direct these two components to their proper general-ledger accounting locations over time. Corporations will be able to calculate effectiveness ratios of hedges based on either spot or forward exposure benchmarks as they wish, and all data and reporting information will be downloadable to spreadsheets and a company's general ledger.

"This is a way of automating something that is quite uncomfortable for many corporations right now,” says Keith Bergman, product manager of the ASP effort. "We're aiming this at companies that don't have a system at all, or don't have a FAS-compliant system, and need a way of valuing their exposure and generating the accounting entries that come out of this. This will certainly not be the only Wall Street Systems ASP initiative, but it will be our first.”

Hewlett Packard will host the ASP on an Atlanta-based data center with full encryption security and firewalls in front and in back of the servers. Interactive Data Corporation will provide real-time data, although customers may choose to override this.

Wall Street Systems will be competing in this space with companies such as PricewaterhouseCoopers' Solution133.com, Integrity Treasury Solutions, FinancialCAD Corp., Trema, Measurisk.com, TGP Software and Reval.com, but unlike some of these, WSS promises to go further in its functionality than simple web-based reports. Accounting entries, for example, can be directly downloadable to a general ledger. Pricing of the system will be based on a one-time configuration charge, plus a monthly subscription rate based on the total number of open transactions. Bergman estimates that in few cases would a corporate face a total cost greater than $75,000 a year.

But FAS 133 compliance is merely the tip of the iceberg for Wall Street Systems. According to Jim Pfeiffer, head of corporate communications, the firm has spent a "massive amount of time” retooling its entire risk management and accounting package. Its goal is to create an ASP that can be delivered to both the front and back office in a "seamlessly vertical application.”

"We perceive an interest in a user-configurable platform, chat functionality for support, and an eventual e-execution interface that offers straight-through processing,” says Pfeiffer. "Our goal is to fully automate trading management and treasury operations.”

How will WSS accomplish all this? Pfeiffer admits that among other available technology, Wall Street Systems will use Citrix Metaframe software to help serve up some of its applications to a browser. Pfeiffer further states that WSS would not have chosen Citrix if it did not meet certain evaluation criteria in capacity, scalability and response time, but that the firm has yet to perform beta testing in the real world. Will Citrix do the trick here? It's hard to tell just yet, but for now, watch out for Wall Street System's Java-based FAS 133 package. It's ready to roll out, and could be the best in its class. If it succeeds, it could ultimately offer Wall Street Systems a strong toehold in the corporate world when it's time to sell its new Citrix-delivered risk management and accounting ASP package.

FinTech

FinTech is a small player in risk management software, but it does something the big firms don't: It supplies a Java-based system over the Internet at a very low cost.

In the mid-1990s, FinTech president John Wolfe, a former O'Connor Associates derivatives aficionado, created a standalone risk management system for two multicurrency convertible bond hedge funds. Now, he has completely redesigned the system at all layers, making it a fully Java-based platform, and plans to roll it out to new users for just $2,000 per user per month. That should be enough to make the 600 pound gorillas in the risk management space blanch.

FinTech's trade entry allows tremendous flexibility. The generic pay-and-receive side of swaps, for example, includes fixed income, equity and currency products—an impressive array. Assets may be purchased and revalued in any number of currencies, and all the data flowing into the system from Interactive Data Corporation (or another vendor the user may select, since FinTech is an open platform) are real-time and web-based.

The system's reporting functions are impressive, too. Reports are arranged in a simple table-object manner, allowing users to manipulate portfolios however they like. One can query the system by upper level fund, by multiple prime brokers, or by multiple trade pairings or strategies, for example. All reports can automatically be formatted into spiffy PDF text files as well, and the suite of offerings includes back-office general ledger, balance-sheet and P&L reporting. The system is particularly strong at tracking and attributing financing costs to the proper securities. Risk reports, meanwhile, are driven by an easily integrated TrueRisk engine. The system even has an instant-messaging functionality and the ability to push pages to individual users.

Does all of this sound too good to be true? According to Ron Santella, managing partner of Chicago-based SAM Investments, FinTech lives up to its billing. SAM has approximately $1 billion in assets under management, and has used both FinTech's previous legacy system and the new web-based version. "FinTech does everything we need it to,” he says. "And while we have spent several-hundred thousand dollars in past years working with FinTech to specify out the functionality we wanted, now it's mostly all there, and Wolfe intends to sell it.”

One word of caution: FinTech may offer real-time delta- and beta-adjusted position monitoring, but certain basic risk reports still don't exist. A simple spot ladder showing the position and P&L effect of various permutations in an instrument's price might be a useful addition. Another might be more explicit hedge fund accounting. For instance, despite FinTech's user-friendliness, SAM Investments still downloads various FinTech reports into other applications to determine final NAV accounting for their investors.

That said, FinTech's small size allows it to be nimble—and flexible. The system is still undergoing various tweaks and updates, but big software vendors trying to migrate down from charging seven-figure licenses should take note. FinTech undercuts the behemoths in pricing and web-friendliness.

Theoretics

Another up-and-coming ASP is Park City, Utah-based Theoretics. This company's traditional client-server software has recently been stealing some market share away from SunGard and Principia by offering mortgage-backed analysis capabilities, cheaper pricing and first-rate customer support with constant upgrades. Now the company hopes to expand this client base even further by moving customers to a web-based platform. The company, like so many others, is using Citrix as a delivery mechanism for now, although president Blaise Labriola says a new Java-based front-end is currently under design.

Theoretics' traditional client-server software has recently been stealing some market share away from SunGard and Principia by offering mortgage-backed analysis capabilities, cheaper pricing and first-rate customer support with constant upgrades.

Primarily fixed-income in orientation but capable of handling other products, Theoretics sports the look and feel of a Windows-tree Explorer view. Users can create directories with the click of a mouse, and drag-and-drop trades, cut-and-paste trades, and slice-and-dice portfolios in multiple ways. Few customers have yet to migrate to the ASP platform, but those familiar with the underlying functionality of Theoretics software sing its praise.

"Theoretics is good value for the money,” says one regional bank risk manager. "SunGard's Monte Carlo simulation module was ridiculously overpriced by comparison—really over the top for our needs. Theoretics allows us to import more than 4,000 positions from SunGard, and get where we want to be risk-wise for much less money.”

Frank Ye, a derivatives structurer at the Federal Home Loan Bank in Boston, says Theoretics not only has a friendlier mortgage interface and better cash-flow analysis, but also updates in real-time, whereas his bank's Principia system does not. Ye is using Theoretics primarily as a front-office tool to evaluate and analyze trading opportunities and hedging choices. Theoretics also counts SunTrust, GMAC, Pepsi, Zurich Capital and Dresdner Bank among its software customers.

Theoretics offers its entire system via the web for $3,500 a month, and users can subscribe to individual modules for far less. Theoretics also offers a complete user guide on-line, and the ability to test-drive an on-line demo system without even providing the company your name. Such accessibility and pricing could help Theoretics pick up even more market share in the fixed-income space.

SunGard

SunGard Trading and Risk Systems is one of the biggest risk management software vendors out there, an amalgamation of previous vendors Devon, Infinity and Renaissance. A publicly traded company with a market capitalization of more than $6 billion, SunGard is the most hush-hush among vendors when it comes to its ASP efforts. As this magazine goes to press, the company was in a quiet period because of earnings season. At its risk management conference in Barcelona in mid-November, however, SunGard promises an announcement and demonstration of a web-based risk management platform called the Panorama Knowledge Factory.

Knowledge Factory is a web-based, post-trade market and credit risk analysis engine that will allow money managers to stress-test their portfolios and view the results easily. Asset allocation professionals will also be able to view into money managers' portfolios. Clare Porter, a London-based product manager for SunGard, says Knowledge Factory will be a standalone platform, although it will also be able to interface with another SunGard effort, eFinity, a back-office ASP. (eFinity is currently being beta-tested by a handful of regional banks in Europe.)

The future

There are other efforts afoot in the ASP risk management space. These include efforts by traditional risk management companies Advent Software, SS&C Technology and Principia Systems. In some way or another, every traditional software vendor is trying to reinvent itself for the Internet—some are simply further along than others.

Despite the ASP rush, it's clear that traditional client-server systems won't disappear overnight. There is just no pressing need for banks to move off systems that still work—particularly since security, off-site data, speed and reliability questions still exist across the board.

But Java-based versions of traditional software packages are coming, as are other new upstarts threatening the risk management establishment. In no time, we should see the price of advanced risk management technology drop a few hundred percent or more.