Inadequate or outdated IT Systems can be an important source of risk and bank failure. In the area of derivatives such risks can create systemic risks. Regulators and auditors can assess whether the systems and controls in a financial institution are sufficiently robust to identify, monitor and manage the risks arising from firms’ IT systems. This assessment tend to focus on risk identification, measurement. It also concentrate on risk mitigation, monitoring and reporting. Increasingly the assessment of IT Systems is becoming an integral part the compliance framework.
A number of guidelines have been provided by regulators on the requirements IT systems (see also System Requirements for Treasury Management by Christian Frisch) that are needed to perform all the complex calculations and process management involved in derivatives transactions. Regulations that have included systems requirement in their rules include: Basel II (The BIS Capital Adequacy Accord) and Sarbanes Oxley. Derivatives Accounting Standards also have some tentatives guidelines that have not been formalized into rules.
Minimum Functionalities
Brokerage and Trading Systems
Comprehensive processing of various derivatives instruments
Securities transaction processing, including order routing and trading support
Execution and clearing, position keeping
Regulatory and tax compliance, reporting and investment accounting
Full front–to back–office support and Record keeping
STP
Increasingly WML (for mobile phones and PDAs)
Basic system requirement for derivatives
Customizable quick trade entry for processing high volume deals
Market data interfaces for a wide range of market data feed systems e.g. Bloomberg
Pricing models including pricing, analytics, ability to retrieve historical market price data
Sensitivity analyses and "what–if" analysis at the trade or portfolio level
Real–time risk covering for single position level and bank wide level, including: credit risk and market risk
Real–time P&L decomposition with the ability to slice and dice the P&L down to individual transactions
Exportable data to Microsoft Excel and Access or SQL
In order to handle derivatives transactions, a standard software should provide a comprehensive coverage of all classes of instruments and have access to independent valuation models library. Valuation models enable timely mark–to–market for all derivatives including OTC and exchange traded instruments.
Even when the software operate as a stand alone tool, it should be able to provide a aggregate views and drill–down menus by currency, asset class or individual trade. Hedge effectiveness testing menus with functionalities that automate prospective and retrospective effectiveness test as well as documentation and reporting output with FpML and XBRL.
The Group 30 recommendations contains guidelines for the the minimum requirements for systems that handle clearing and settlement. These systems must be able to provide simultaneous delivery versus payment in the national and international sector and clearing in all major currencies. The standard settlement time is "T+0" settlement.
Modern system typically offer "Pre–matching" through value date monitoring the functionalities to manage cash payment of interest, dividends and reimbursements on the correct value date. These requirements are vital in operations involving securities lending and borrowing of securities and also in investment of overnight money and related interest payments
The Group of 30 requires the linkage of IT systems with national and international clearing corporations which enables settlement throughout all time zones on the correct value date.
Last but not least all systems must be able to generate documentation for reporting
and have record keeping functions for example via a data base.