Risk and Pricing Analytics: Addressing Valuation Challenges in OTC and Structured Products

by Cubillas Ding, June 5, 2007


London, United Kingdom 5 June 2007

Celent predicts OTC derivatives will cross the US$550 trillion mark in 2008, up from US$375 trillion as of year end 2006.

Growing OTC derivatives trading volume, escalating exposure to over-the-counter (OTC) derivatives and structured deals, the increased complexity of products, and lack of trade automation have increased the importance of accurate valuation, according to the new Celent report, .

Recent incidents associated with Amaranth Advisors and Bank of Montreal’s loss illustrate the risks associated with the use of derivative instruments. They also bring to light the need to address inappropriate valuation practices and insufficient management oversight. At the heart of things, pricing and valuation of financial assets are core to a financial institution’s existence and tied to the stability of the financial sector as a whole. Accordingly, getting it right is crucial.

"As a whole, the determination of fair market value for the positions that make up a complex trade, fund, or portfolio is, more often than not, fraught with complications," says Cubillas Ding, Celent analyst and author of the report. "Complexities often arise from multi-layered product valuation requirements, the fault-prone use of spreadsheets, and the transparency of valuation processes."

To address this situation, vendors have adopted different "routes to market" for pricing analytics. Solutions are differentiated along several lines: specialized vs. mixed asset models, coverage across various parts of the OTC and structuring lifestyle, scope of vendors’ analytics, and the quality of partnerships related to market data, integrated trading, and risk management systems.

Ding says that institutions implementing pricing solutions need to weigh the level of granularity required for their OTC derivatives and structured products valuation activities, the type and nature of users, and time-to-market considerations in the context of the availability of internal resources. "Each approach trades off granularity, end user focus, and time to market," he adds.

In this report, Celent examines the activities around securities pricing and draws lessons from valuation challenges, as well as highlighting considerations for the implementation of solutions.

Eight firms are profiled in this report, which contains pertinent information about each vendor solution, including company and organizational details, solution strengths and drawbacks, reference feedback, market presence, and solution coverage. Vendors covered include FinCAD, NumeriX, Pricing Partners, Quantify Solutions, SciComp, SunGard Reech, SuperDerivatives, and UniRist / MathConsult.

The 45-page report contains 19 figures and tables. A table of contents is available online.

Members of Celent's research services can download the report electronically by clicking on the icon to the left. Non-members should contact info@celent.com for more information.  

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is a wholly-owned operating unit of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

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Table of Contents

London, United Kingdom 5 June 2007

Executive Summary 3
Introduction 5
Market Developments and Trends 6
  OTC Derivatives 6
  Financial Innovation and Complex Instruments 8
  Regulatory Demands 12
Business and Technology Considerations 13
  Implementation 'Routes to Market' 13
  Segments and Characteristics 14
  Challenge of Pricing and Risk Analytics 16
Selected Pricing & Risk Analytics Software Vendors 18
  Celent's ABCD Vendor Analysis Framework 18
  Criteria for Inclusion 18
  Vendor Overview 19
  Solution Technology Overview 21
  Pricing 23
  Implementation Routes-to-Market/Approaches 26
  Coverage in Institution's Product Lifecycle 27
  Asset Class and Vendor 'Sweet Spots' 28
  Partnerships 29
  Vendor Strengths and Weaknesses 30
  Celent ABCD Vendor View 34
Solution Selection & Implementation Considerations 36
Lessons - Managing Pricing and Valuation Risks 38
Conclusions/Looking Forward 41
Appendix 42
Objectivity and Methodology 44

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