By Bob Cumberbatch, business lines director, Interactive Data (Europe)

Now is a critical time for organisations to prioritise reference data management. Managing reference data has not always been viewed as a major corporate priority. Often seen as data processing and record keeping, it has not been an essential component of a risk management strategy for a multinational financial institution. But with the volatility of the global financial markets and subprime issues, risk management is today’s focus and high quality reference data plays a vital role in supporting this.

By optimising reference data management, and thus having an in-depth knowledge of the millions of financial instruments flowing through its systems, an institution can take a holistic approach to effectively managing risk.

Critical to this approach is the ability to take a 360 degree view of each financial instrument held by an institution, understanding the behavioural characteristics, both on a standalone basis and within the context of the portfolio, under a variety of market scenarios. Determining how an instrument is going to behave under stress is essential to understanding the risk parameters of that instrument. With accurate and consistent reference data, an institution is better positioned to conduct the kinds of analyses that are critical to understanding risk.

At another level, financial institutions want to understand the concentration and exposure they have to various segments of the market. This might include credit exposure and industry segment exposure, among others. Gaining this understanding requires knowledge of the full ‘family tree’ of a financial instrument. For example, if an institution owns shares in a certain company, it may not realise that this company is a far flung subsidiary of a major auto company going through financial difficulties that could impact its holdings.

With reference data, an institution could have a better understanding of its ‘concentration risk’ in a certain sector or among organisations that are facing challenges. For example, an institution could identify that the exposure to the auto industry makes up too large a percentage of its portfolio, and then make an informed financial decision to address this issue.

Reference data providers can offer clients detailed entity linkage information that connects families of securities and helps institutions understand the relationships of the securities to the corporate family structure. This information is critical to maintaining compliance with regulations that require institutions to understand their exposure to a given firm, industry or market sector.

It is also essential to have a comprehensive understanding of the underlying elements of a financial instrument. Over the past few months we have read stories about firms that didn’t take these steps and have been impacted by the far reaching tentacles of subprime securities.

But it wasn’t just financial institutions that have invested in structured securities, such as CDOs, that had exposure to subprime loans. In recent months, entities from government organisations to pharmaceutical companies have disclosed losses due to subprime related issues.

Effectively managing and reviewing reference data can help investors understand the underlying dynamics of a security and help them determine their risk exposure. For example, even though a security may have an AAA rating, that rating may be supported by internal or external credit enhancement. To understand the risk profile of that security, it can be crucial to know whether that credit enhancement will hold up under stress. With consistent, timely and accurate reference data, institutions can gain additional transparency into these details.

By prioritising reference data management, institutions can get a more complete understanding of the financial instruments streaming through their applications and databases, and as a result manage risk more effectively.

For further information please contact Bob Cumberbatch, robert.cumberbatch@interactivedata.com
Interactive Data Corporation (NYSE: IDC) is a global provider of financial market data, analytics and related services to financial institutions, active traders and individual investors. The company’s businesses supply real-time market data, time-sensitive pricing, evaluations and reference data for millions of securities traded around the world, including hard-to-value instruments.
Interactive Data offers a wide range of reference data that can help customers comply with capital adequacy, best execution and transparency.
www.interactivedata.com
This article is provided for information purposes only. Nothing herein should be construed as legal or other professional advice or be relied upon as such.