Since the financial crash of 2008, the attitude to risk and risk management within banks and financial services has changed dramatically. The overhead of implementing and running appropriate 3 lines of defence across banking businesses has increased year on year, with material issues arising from controlling market abuse (Libor, for example) through to Anti Money Laundering (punitive financial fines imposed of multiple $bn).
The Importance of a Robust 3 Lines of Defence
Adopting a rigorous 3 lines of defence model across the business allows banks to approach risks in a standardised way. The risks arising from poorly managed agreements between counterparties are no different and one that has itself come under increasing scrutiny following the banking crisis. The need to manage bilateral risk has been highlighted as a critical area of risk with the potential for substantial financial impact on the counterparties should things go wrong.
Protecting banks against breaching agreements held with counterparties and a rigorous approach to appropriate stewardship of all agreements that are in place has become a key regulatory concern. Manually, this often results in post-trade activity and monitoring which attempts to prevent risks from limit breaches escalating rather than preventing at the outset. It is clear that real-time governance of agreements is necessary to effectively prevent risks and limit breaches prior to deal and transaction execution.
Challenges of Managing Agreements
In the decade post-2008, the echoes of the financial crash still reverberate within markets still reeling from poorly managed activity which exposed the industry to systemic failings. In relation to agreements, attempts have since been made to enhance controls around margin arrangements for uncleared instruments. As recently as 2017, ‘in-scope’ firms attempted to become compliant with phase 1 of the BCBS-IOSCO framework, but it became clear that the challenge was too difficult with regulators recognising that many firms were falling short of the requirements owing to operational and technological constraints.
Firms were struggling with a lack of automation combined with the new, very real requirement of needing to adopt an effective 3LOD model across their businesses. Significant paper trails were causing a real headache as documents passed from legal, to middle office, to risk, to operations and back to the front office by way of limits and trading restrictions. This is indeed difficult enough within one firm but when you consider the issue between two or more firms trading with each other, the issues escalates quite quickly to a fairly chaotic situation, which in turn increases timeliness in ability to transact, reduces the appetite to trade, reduces liquidity and competitiveness in such markets.
Technology as a Solution
Since the chaotic environment of 5 years ago, technology has stepped up and attempted to provide all manner of solutions including AI-based solutions. These solutions have been developed to help automate the process of managing agreements, and to provide real-time monitoring and governance of agreements. This has helped to reduce the burden on firms and to provide a more efficient and effective way of managing agreements.
Protecting your agreements with a robust 3 lines of defence is a critical aspect of risk management in the banking industry. The need to manage bilateral risk has been highlighted as a critical area of risk with potential for substantial financial impact on the counterparties should things go wrong. Adopting a rigorous 3 lines of defence model across the business allows banks to approach risks in a standardised way, and technology has played a key role in providing efficient and effective solutions for managing agreements.