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Room for ExpansionIn today’s market, many data managers talk about funding for projects being pulled and limited spending on new initiatives. But this is not necessarily the case for evaluated prices. Turbulent market conditions and a focus on reducing risk have led to a rapidly growing demand for evaluated prices—a demand that has rocketed so fast that some worry vendors have not had time

to prepare for the consequences. Yet, the vendor community has already reacted to changing market conditions and

is continuously improving its services. In fact, even users specializing in this area are impressed with the quality of some of the offerings.

There is also an increasing realization that taking all data available, including vendor prices, is the only way to reduce valuation risk. It is quite clear that no-one will ignore the risk manager in the coming years and valuations will be one of the areas risk departments are expected to take a closer look at. This means evaluated prices continue to be a growing market, where vendors see opportunities to expand.

With this special report, which includes comments from industry experts and a news review, we hope to provide readers with an insight into the latest development in the evaluated prices space.

Yours sincerely,

Tine ThoresenEditor, Inside Reference DataEmail: [email protected]: +44 (0)20 7004 7470

Editor’s Letter


Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process.Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.

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Standard & Poor’s Cross Reference Services provides comprehensive referencedata across the securities universe. It can assist you in keeping a check onconcentration levels, identify where your firm has multiple risk points and helplimit your exposure to individual states. What’s more, it’s designed to be flexibleand responsive, so it can meet your firm’s own specific requirements.

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NEWS6 JPMorgan Enhances Securities Pricing Model

6 Downturn Puts Evaluation On Agenda

7 Vendors and Exchanges Create New Opportunities for EDM Providers

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FEATURES8 Virtual Roundtable Inside Reference Data gathers leading professionals to discuss pressing issues related to evaluated prices and explores how the recent market turmoil has impacted the industry

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26 Q&A IRD speaks to John Jay, senior analyst, Aite Group about how the credit crunch is impacting the evaluated pricing space

Contents

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New York—JPMorgan Securities Services has in the past year enhanced its securities pricing operations, creating a three-hub model in Edinburgh, Dallas and Mumbai, officials tell Inside Reference Data.

Peter Serenita, who was made global head of pricing operations at JPMorgan Worldwide Securities Services in February, says: “When I arrived we had one hub servicing our European Fund Accounting clients. We have taken that model and expanded it to the other regions, then hooked up each regional pricing hub into a global unit.”

With the new and enhanced operating model, the firm operates with a follow-the-

sun approach that covers all time zones.Serenita has also moved coverage

between hubs. An example of the migra-tion into the global operating model was the move of the late shift in Edinburgh, which covered the US market closes for European clients, to Dallas, so these prices could be validated in normal business hours.

Hong Kong fund accounts also used to be serviced out of Dallas, but this has been moved to Mumbai, which works better with the time zones.

The full version of this story appeared in Inside Reference Data, December 2008.

Tine Thoresen

� March 2009 www.irdonline.com

News Review

JPMorgan Enhances Securities Pricing Model

LoNdoN—The economic downturn and increased regulation have put pressure on firms to ensure they have sufficient evalua-tion resources, according to speakers at the European Financial Information Summit held in London in September.

“This year has definitely been the year of evaluation and 2009 will be even more so,” said Magnus Cattan, manager, fixed-income and derivatives, Interactive Data.

In August, UK regulator the FSA sent letters to professionals responsible for evalu-ation controls. Chris Johnson, head of data management, institutional fund services Europe, at HSBC, quoted from an FSA open letter, sent in August 2008 to the CEOs of

banks and investment firms, stating the FSA’s view that “firms’ valuation processes are becoming increasingly stretched and in some cases are “materially flawed or inad-equate.” FSA chief executive Hector Sants warned against snap decisions on headcount reduction in the area of valuations.

Cattan expects to see regulators a lot more involved and regulation “hopefully more defined.” This means the vendor focus on evaluation services is likely to continue. Panelists said they anticipate a boom in vendor competitiveness in the next year.

The full version of this story appeared in Inside Reference Data, October 2008

Carla Mangado

Downturn Puts Evaluation On Agenda



News Download

LoNdoN—Several enterprise data management (EDM) platform vendors recently secured sales to other data companies, marking a shift toward more vendors and exchanges embarking on data management projects.

Paris-based independent valution provider Prime Source, a NYSE Euronext company, has purchased the enterprise data management platform AC Plus from software vendor Asset Control, while the European trading venue Chi-X has acquired data management vendor Cicada to create a new technology division at Chi-X.

Nathalie Masset, head of projects at NYSE Euronext, says data management is extremely important in the independent valuation business, which Prime Source is in. “Prime Source has access to a wide range of data, which means we need a system to handle the data,” she says.

With the new platform, the vendor will have a golden copy to use in the valuation process, improved transparency to help track the process and reduce risk of human errors. Masset says improved data management capabilities will also help the company answer questions from clients about valuation calculations and underlying data.

The improved data management system can even be a competitive selling point for Prime Source. It has advertised its data management focus in its marketing brochure, highlighting the increasing importance of EDM to data providers.

The full version of this story appeared in Inside Reference Data, December 2008

Tine Thoresen

Interactive Data Teams Up with Prism ValuationBedford, Mass.-based Interactive Data has entered an agreement with Toronto-based independent valuation service provider Prism Valuation to provide valuations of highly complex OTC derivatives and structured products. Interactive Data’s clients will be able to request valuations on a per-instrument basis, which will be calculated by Prism Valuation’s quantitative anal-ysis team and then delivered via Interactive Data’s securities admin-istration tool.

Interactive Data has also expanded its Pricing and Reference Data busi-ness interest rate swap valuation service by adding 15:00 EST valu-ations, independent valuations for compounding swaps, and historical valuations for interest rate and credit default swaps.

Thomson Reuters Launches Valuation Risk Product Thomson Reuters launched a valu-ation risk product at Sibos 2008—a true ‘re-purposed’ offering. The service combines a global pricing and security reference data service with the risk management portfolio Kondor and Reuters 3000 Xtra pric-ing libraries.

Vendors and Exchanges Create New Opportunities for EDM Providers


Following the credit crunch, regula-tors have expressed a growing inter-est in valuation processes. Is there a need for increased regulatory involvement?Chris Johnson, head of data management, fund services, europe at HSBC Securities Services: Historically, the regulators show a strong oversight of retail collective funds such as OEICS and SICAVs. These are the types of funds that have a direct effect on retail investors’ investments and the published fund unit prices at which they can buy and sell their fund units. When managing a pricing team on the buy side, this means the greatest intensity, in terms of regula-tion, is placed on prices for those retail funds. I anticipate increased focus on pric-ing of other types of fund, such as hedge funds, segregated institutional funds and pension funds.

Shant Harootunian, managing direc-tor, evaluated services, Interactive data Pricing and reference data: While arguments could be made for and against increased regulatory involvement, we have seen some positive effects of regulatory focus on valuation processes. Our clients have increased the number and depth of their due diligence discus-sions with us, and as a result have a better understanding of how we prepare evaluations. In addition, following FASB’s implementation of FAS 157, firms have had to review their valuation policies and procedures and develop procedures for fair-value disclosures in their financial statements. An important element of the FAS 157 review process is for firms to understand the market inputs for evalu-ations so they can make their fair-value hierarchy determinations.

Interactive Data advocates increased

Succeeding with PricingInside Reference Data gathers leading professionals to discuss pressing issues related to evaluated prices and explores how the recent market turmoil has impacted the industry

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transparency, and therefore we believe the transparency called for under FAS 157 is a positive step for the industry. We also feel it could impact other related areas. For instance, we would like to see more manda-tory trade reporting around the globe, similar to what is done through TRACESM and the MSRB, which could offer evalua-tion providers and financial institutions easier access to market information that could be utilized as an input to evaluation and valuation processes.

Lydia Galasean, financial analyst, SIX Telekurs: Given the dramatic events in the financial markets over the past two years, one can argue there is definitely a need for increased regulatory involve-ment. However, one has to be very care-ful here. Regulation should not hamper the free markets and the ability of market practitioners to perform their respective [tasks]. There are good and bad exam-ples of regulatory intervention. A bad example thereof was the banning of short selling, albeit for a short period of time during 2008.

Successful short selling is a sign for overinflated prices and the necessity for a market correction. Banning it is the same as shooting the messenger. The other thing to bear in mind is that no matter how much regulation there is in place it will not stop anyone with real knowledge and skills abusing the system and circum-venting the rules. What will help more in this context is not regulation but the willingness

and commitment from market practitioners and in particular risk managers world-wide to fully understand the risk their companies face and act accordingly.

Liam davis, head of data manage-ment, europe, Middle east and Africa, Northern Trust: Companies such as Northern Trust aim to meet what is termed “best practices,” and do so by defining a set of standards and gover-nance processes around determining these best practices. However, given the systemic problems around the marking of bonds and the sudden writedown of bank-held positions, it may be helpful for the regu-lators to devise a more formal structure around how valuations are struck through, and which provides more definition for the approaches vendors should take.

Particularly in times of illiquidity, setting out globally regulated industry-wide evalu-ation standards would not be viewed as an imposing measure.


Shant HarootunianManaging Director, Evaluated ServicesInteractive Data Pricing and Reference DataTel:+1 877 462 3843www.interactivedata.com


Frank A Ciccotto Jr, senior vice president, Standard & Poor’s Securities Evaluations: In today’s market-place, regulators are in a difficult position as they seek to strike and main-tain a balance between “mark to market” and other market pressures that impact how securities are valued. This is especial-ly true when evaluating structured finance and other less liquid types of securities, including CLOs, CDOs and mortgage-backed securities. Regulators’ ability to provide the market-place with an accept-able method to address “mark to market” as well as helping it effectively manage the call for additional valuations is para-mount to the pricing process. At Standard & Poor’s, we can provide the market-place with two types of approaches: mark-to-market and the independent model-based value approach, through our Fixed Income Risk Management Services group.

Ian Swain, executive vice-president, data, Statpro Canada: While over-regu-

lation is not the path of choice to take, StatPro views increased regulatory interest as a positive step. Having increased visibil-ity in the evaluation process will at least address what we believe to be the primary issues—independence and operational risk. Promoting independence in the valua-tion process allows a sober, second thought into the process. Markets are changing fast. Trading on many traditionally liquid secu-rities “froze” in recent months, and market makers are not willing or able to commit to providing consistent and open levels on secu-rities. Regulators have the ability, and obliga-tion, to act and ensure funds and custodians are reviewing their valuation processes in their entirety. From an operational point of view the valuation process is key to giving consistent, accurate valuation levels. For funds or custodians to find themselves in a position where assets have unreliable valu-ations is unacceptable. Regulators are in a unique position to monitor the processes and provide guidance, and if necessary, enforce fairness, to the end-shareholder.

Alberto Ricciotti, head of group pricing, capital allocation, planning, finance & administration, UniCredit: There is a need for more regulation in this space. We focus on our own banking book and we do not focus on the trading aspect. I do think greater regulation will lead to more attention on some of the aspects of evalu-ations. But I think regulators have already focused on this, and it is the banks that are not doing enough now.

Virtual Roundtable

10 March 2009 www.irdonline.com

Lydia GalaseanFinancial Analyst, SIX TelekursTel: +41 (0)44 279 5212www.six-group.com


www.six-telekurs.com

In a multi-faceted market, our Fair Value Pricing Service offers trans-parent valuations for your fixed income securities. SIX Telekurs under-stands that you need to base your analyses on figures which are uniform and transparent.

Our Fair Value Pricing Service applies a systematic, engine-driven calculation method. Therefore, we can provide you with fair value prices, undistorted by market rumour or sentiment.

You can look up and monitor every step of each calculation to under-stand exactly how we got there. We offer valuations of over 56,000 bonds and 26,000 floating rate notes in eleven different currencies, four times a day.

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karl Mackelburg, head of structured fi nance and derivatives pricing and Malcolm oldham, head of evaluated pricing—europe and Asia, Thomson reuters: Yes, there is a need for increased regulation, but government and the regula-tory bodies need to be cautious in avoiding over-prescriptive treatments with unin-tended consequences. Issues arising from this crisis include the role of fair-value accounting, transparency of data and pric-ing information, over-reliance on ratings and the impact of leverage.

Government should focus on the root causes—for example, how to better assess risk in the system, where increased trans-parency is required and the obligations of market participants. Regulators need to provide a more detailed implementa-tion framework, in consultation with the industry, to ensure new rules are practical and address the problem correctly.

Self regulation must also play a role. ISDA, for example, played an important part in promoting and policing the deriva-

tives market. Evaluations can follow a similar path, because many market partici-pants understand best-valuation prac-tices. For example, the mortgage industry could decide on a standard baseline valua-tion based on dealer contributed prepayment and default rates—such an approach is best defi ned and implemented by the industry.

In what ways do you expect strategies for pricing illiquid assets to change in the aftermath of the fi nancial crisis?Johnson: There has been no real change, in respect of asset pricing, for those assets that have always been illiquid in respect of market prices. Model-based evalua-tion services were established long ago to support them. What has changed over the past 18 months or so is that some assets, such as certain corporate bonds that were historically traded frequently have become newly illiquid. Therefore, market prices are more diffi cult to source reliably. My view is that we should still seek reliable market prices for such bonds wherever possible and regard model-based evaluations as the pric-ing option of last resort.

Harootunian: As a provider of indepen-dent evaluations for fi xed-income securi-ties, Interactive Data places an emphasis on “detecting and refl ecting” market activity, regardless of market conditions. To produce our evaluations, we incorporates trade, bid and other market information, including loan performance data when it is available, into our evaluated pricing applications and

Virtual Roundtable


Frank A Ciccotto JrSVP/Standard & Poor’s Securities EvaluationsTel: +1 212 438 4417

www.standardandpoors.com


models for fixed-income securities. In addi-tion, Interactive Data has long-standing rela-tionships with market sources who provide us with insight into daily market activity.

We believe market conditions over the past couple of years have helped to drive demand for independent evaluations from providers such as Interactive Data, as institutions seek to utilize inputs from a range of sources for their portfolio valuation process.

Galasean: I do not expect the strategies of pricing illiquid assets to change, if at all only marginally. When calculating theo-retical prices, quantitative analysts rely on established methods. If there is high illiquidity, the market calibration will be more difficult and not as reliable as in the case with high liquidity, but on the whole very little changes. Analytically calculated prices work on the principle that one takes into consideration as much market inputs as possible. If there is not much to consider then the prices are calculated accordingly. I expect the overall number of illiquid securi-ties to increase dramatically but I do not see a strategy change for pricing illiquid assets. We have always had market segments with high illiquidity, the only difference these days is the fact that there are a lot more of them than there used to be.

davis: The era in which market participants had relative confidence in the successful repayment of asset-backed debt has ended. In 2009, Northern Trust has seen greater interest from audit firms with respect to the

liquidity of asset-backed bonds. The audit view on these assets has become “are these assets really worth the price that has been allocated to them at year end?”. In other words, if a portfolio had to be liquidated, then would these prices have been achiev-able given the distress in the asset-backed bond market? Views differ on valuations based on the strategies portfolio manag-ers are pursuing, but in any market, excess sellers will drive down the price. Given the fact there is little transparency in the asset-backed bond market, it is not clear at what price an asset-backed security (ABS) would trade if a portfolio required cash. Many firms rely on vendor-provided bond evaluations to capture the current market value. I expect evaluated bond data vendors will be looking at their cashflow information providers to test the quality of cashflows and seek reas-surances the information is current. I would also expect lead managers of asset-backed debt will be asked to provide mark-to-market information with greater frequency as audit firms seek confidence in the pricing levels used for year-end financial reports.

Ciccotto: Standard & Poor’s FIRMS offer-ing, Valuation Scenario Services, offers an alternative evaluation approach. The analyt-ics provided by Valuation Scenario Services offer investors a step-by-step, transparent assessment of their structured portfolios under a range of different assumptions and economic scenarios. This information is then reviewed in a collaborative decision support process with clients to help drive an improved



understanding of structured credit portfolio value. Standard & Poor’s Valuation Scenario Services operates independently from the company’s ratings units.

Swain: First, we will see the challenge of the model. Questions will be asked of vendors and evaluators—How is the security priced? What are the inputs? Assumptions? Full disclosure as to how the levels are being derived will be (and indeed are being) asked. While the formulas themselves are fairly standard, and expected to be transparent, we must ensure the significant variables are likewise scrutinized and understood. I think strategically, funds and custodians will be looking for input into how to properly value securities, whereas, in the past they may have simply relied on being supplied with the end result. Now more than ever, I think we all realize the importance of transparency.

ricciotti: The pricing models for illiquid assets should start to take into account a number of risk factors that have not been considered or dealt with in an appropriate

way in the past. In addition, the valuation of banking book assets seems to be losing importance right now, especially due to the credit crunch. By using fair-value pricing of portfolios, there is a risk of reporting losses due to the current non-favorable economic climate. This means paradoxically the fair-value valuation loses importance.

Mackelburg and oldham: They have already changed. Credit, counterparty and liquidity risk are all critical drivers of price today, having been on the back burner in the middle years of this decade. In benign conditions, buy-side firms could use dealer marks as a measure of fair value supported by tight spreads on trade prices and consis-tent independent vendor prices. Now dealer quotes vary significantly with wide spreads, and trade prices often reflect distressed situ-ations that need to be analysed. The impact of that has been increased due diligence from the buy side both in increasing reliance on time-specific independent evaluations that can draw on multiple market sources, and in quality assurance processes to assess price accuracy.

what is the best way to deal with the growing spreads and high numbers of tolerance breaks brought on by the turbulent market conditions?Johnson: The challenge we face is from individual price contributors that publish price quotes with very large spreads, and are inconsistent with other market quotes for the same asset. One way of overcoming this is

Virtual Roundtable


Ian SwainEVP, DataStatpro CanadaTel: +1 514 842 5091www.statpro.com


to try to use consolidated market-averaging sources, such as Xtrakter/ICMA, and to try to weed out any broker-contributed prices with extremely large spreads. Only those price contributors that can be relied on to provide consistent quotes should be used. A further tactic is to re-examine the tolerance levels, as used in price quality validation, to take into account the much-increased price volatility evidenced in certain markets over the past 18 months or so.

Harootunian: Preparing evaluations in turbulent market conditions has required Interactive Data’s evaluators to spend more time assessing the market information they receive, and to review more tolerance breaks on volatile days. I believe establishing open lines of communication with clients and keeping them informed of unusual events is especially critical during these times of heightened volatility.

To help accomplish this objective, Interactive Data has introduced a daily market commentary that reflects activity in the US fixed-income markets as of mid-day. We have also rolled out a daily corporate tolerance report that identifies US corpo-rate bonds and US convertible bonds whose percentage change in evaluation from the previous day is equal to or greater than a predetermined tolerance level. In addi-tion, on days when there is a significant market movement, or if a particular asset class moves in the opposite direction of the market, we convene an internal committee to discuss the situation and determine if

Interactive Data should issue a special advi-sory to alert clients to this market activity.

Galasean: To start with, turbulent market conditions are not a rare occurrence if you look back at the past 20 years history of the financial markets. It should not take anybody by surprise. Tolerance limits should not be placed as absolute numbers. If this is the case, surely you will see a lot of tolerance breaks in turbulent markets. A much better way of solving this problem is the usage of dynamic tolerance limits that consider market movements and the state markets are at any point in time. These types of toler-ance limits are very seldomly broken.

Spreads should also not be thought of as static quantities. There is no strategy that can be called the best way of dealing with growing spreads. Imagine the situation in the financial markets where the spreads are diminishing by the day. Would that be any better? I do not think so.

davis: Custodians and fund administra-tors, such as Northern Trust, along with risk and performance reporting depart-ments, must ensure the growing number of price exceptions brought on through diminishing liquidity are managed in a consistent manner and work with their pric-ing vendors to ensure evaluation models are primed with up-to-the-minute data through information sharing. Since September 2008, Northern Trust has seen an ever-increas-ing number of day-by-day market price movements coupled with widening bid/offer



spreads.. We rely on a multitude of market sources by which we can validate the delta. Pricing, similar to good journalism, requires multiple sources of information to establish a norm. Sell-side firms issuing information through various market data vendors must ensure they can corroborate the information being made available to the marketplace. Regulators and industry associations may also wish to provide direction on best prac-tice during these turbulent times.

Ciccotto: Improvements are needed for the challenge and review processes, includ-ing designing and implementing a process to effectively deal with pricing variances between two or more market participants (vendors). Improvements in these processes should be discussed at the industry level.

Standard & Poor’s Securities Evaluations

(SPSE) treats both a price challenge and a price compare the same way—as a price challenge. Moreover, we have found by auto-mating these processes, we have created a more efficient record-keeping system for the evaluation service and the user, and can respond in a more timely and more effective manner to client price challenges.

Swain: Data, data and more data. With the sudden decline of liquidity seen in the past few months, coupled with the volatil-ity and indecision in the market-place, we have had to look to alternative methods to consistently provide accurate evaluations. Using liquid and various associated secu-rities to help value instruments that have no active quoting market is one addition to StatPro’s models. Another is to value secu-rities in multiple ways, such as mark-to-market, mark-to-model and mark-to-matrix. Constantly challenging and reviewing once-standard models to ensure anomalies and spikes are addressed throughout the valuation process. Firms that apply such an approach, or at least reach out to vendors who do, are in a much better place to be able to rely on and justify their valuations.

Mackelburg and oldham: Market exper-tise and insight are more important than ever in assessing prices. Yield curve shifts, large interest rate movements, huge credit swings, and volatile news flow create an environ-ment that challenges any system based on algorithms alone. Fixed-income profession-als understand how different security types

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Karl Mackelburg (top) Head of structured finance and derivatives pricing, and Malcolm Oldham, head of evalu-ated pricing—Europe and AsiaThomson Reuters Tel: +1 646 822 4800www.thomsonreuters.com


react to interest rate changes, credit changes, and liquidity perceptions and can intervene proactively to more effectively tune pricing engines and bring individual attention to specific issuers and issues.

How can firms best ensure minimum exposure to valuation risk?Johnson: First, to follow dual price check-ing where two market price sources are available for the asset. Second, to scrutinize price sources for any assets that are only available from a single market source and define trusted market suppliers for them. Finally, to ensure there is a formal written pricing policy to govern the procedure in terms of price sources and quality checks.

Harootunian: We believe firms can help minimize their exposure to valuation risk by utilizing a range of inputs to their port-folio valuation process, including indepen-dent evaluations from organizations such as Interactive Data. Independent evaluations reflect information from multiple sources, as opposed to broker quotes, which may only reflect the view of an individual broker. Firms can also help to minimize exposure to valuation risk by utilizing independent evaluations on a daily basis, as opposed to a weekly or monthly schedule.

It is also important for firms to spend time with their evaluations providers to ensure they have a comprehensive understanding of each provider’s processes and methodolo-gies. Interactive Data conducts these types of due diligence meetings with clients on

a regular basis to help ensure the lines of communication are well established.

Galasean: First of all, firms should focus on buying fully transparent solutions. The key to minimizing one’s exposure to valua-tion risk is an in-depth understanding of the underlying pricing methodology. A black box package will not give any insight into how the prices have been calculated. The valuation risk could be very high. Even with a fully transparent solution I would be care-ful. It is crucial the people who have devel-oped the product have extensive market experience, knowledge and most impor-tantly market intelligence. Academics tend to have a different view on many aspects of the calculations. No matter how sophisticat-ed the valuation models are, they are mere approximations of the real world and the markets will always have the final say.

Second, firms should employ qualified and skilled staff who can judge whether the pricing methods, input parameters and data are of adequate quality and reflect the prevailing market conditions.

davis: I consider this to be the most chal-lenging function of firms in our sector. To minimize the risk is predicated on having the best available information at your disposal when making decisions. Each firm has to endeavor to gather the most relevant infor-mation using all the sources at their dispos-al, then making valuations decisions based on best available data. This has been a trial in the current environment given less than



favorable liquidity. Our community must use consistent policies and defer to those who are direct market partici-pants to establish the most appropriate pric-ing levels for troubled asset types. While taking into account the need for independently sourced information in order to strike a fair and balanced portfolio valu-ation, we must appre-ciate vendor sources may not always have the prescient informa-tion relating to some distressed debt issuers. Therefore, firms must be more conscious of guidance from those more closely situated to the trading floor who

may have more insights into the specific trading patterns of the illiquid assets.

All providers of information, whether they be traders, vendors or fund managers, need to be considered when in doubt.

Ciccotto: To minimize exposure to risk, firms could employ a number of valuation providers including independent evalua-tion providers such as Standard & Poor’s, brokers/dealers, auditors, and providers of FASB Level III pricing if none of the observ-

able inputs provide clarity. In partnering with a number of independent providers, the firm utilizes a new level of checks and balances to continuously monitor the market for observable inputs. Additionally, access to a number of different market resources such as exchanges can also be helpful in mitigating some of the valuation risk.

Swain: Know your vendors. Understanding the valuation process is important. Unanswered questions should be followed up on and satisfactory resolutions pursued. Having multiple vendors delivering a multi-tude of evaluated prices will allow you to catch anomalies quickly and red-flag poten-tial future problems. Combining this with transparency into how individual securities are valued, will reduce the possibility of being caught out on mis-valued securities.

Ricciotti: The models have to be continu-ously verified—especially since one aspect that usually receives little attention is test-ing the models’ effectiveness.

Mackelburg and Oldham: Transparency and integrity of information is critical. Without this it is impossible to assess the relative merits of different financial instru-ments and the risks to which a firm is exposed. Transparency means all the data required to make an informed decision is available to the firm. Integrity includes the need for attributes such as consistent data definitions and clear standards for normal-ization of data. For example, differing stan-

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Chris Johnson, HSBC Securities Services

Alberto Ricciotti, UniCredit


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dards for mortgage origination in Europe makes cross-border comparisons very diffi-cult. If in addition, the data is sourced from different vendors who normalize to differ-ent standards, the risk assessment process is very challenged. This market crisis has

revealed that the transparency and integri-ty of market information was inadequate for the speed at which the market was operat-ing. This ‘friction’ in the market’s operation was eventually exposed, and it is essential we address these issues systematically as we move forward.

while the market has seen rapidly growing demand for evaluated prices in the past year, third-party vendors have focused on expanding offerings and helping clients meet new require-ments. But have vendors expanded too fast to meet client expectations for these services?Johnson: To be the best, the evaluation services are by definition expensive and proprietary, and the industry is increasing-ly trying to move away from expensive and proprietary products. But technically there are some extremely good services available. The ones that are very good are the ones that are very demanding. I like the ones that are prepared to refuse to price the really

complex instruments because it provides re-assurance that they are researching the instruments properly. The best services review the terms and conditions of each issue and ensure they really understand the details of the bond before they evaluate.

Harootunian: Interactive Data places a strong emphasis on expanding coverage and rolling out new resources. However, we strive to ensure our new offerings are aligned with the needs of our clients and that we have access to timely, accurate reference data and market information to help enable us to “detect and reflect” current market activity when producing evaluations.

Over the past few months, we have helped address client needs by adding coverage of larger numbers of OTC deriva-tives and complex securities with our expanded interest rate swap valuation service and through an exclusive agree-ment with Prism Valuation. We have also introduced new informational resources that provide increased transparency into our fixed-income evaluations, including an Evaluations Input Report that provides historical details on market inputs for a selected set of security evaluations.

Galasean: I would say the opposite is true. There are whole illiquid market segments where no vendor has anything to offer. One example thereof is the KRW-denominated bond market. The same holds for some parts of the South American fixed-income market segment. Many vendors are very cautious

Virtual Roundtable


Liam Davis, Northern Trust


about venturing into uncharted waters. Some of the difficulties lie in the lack of reli-able credit ratings and more generally static data and market data not being available. However, even in such cases, the principle of making the best use of what is available, holds. Many clients have therefore been forced to go down to level 3 in the IAS 39 regulation and calculate prices themselves. I would like to see more vendors offering valuated prices for a much wider range of financial instruments than what is current-ly available in the market.

davis: The growing challenge within the industry is keeping pace with the ever-changing evaluation environment. The European market has grown expeditiously over the past 10 years, especially within the structured finance sphere, and lacks the structure of the more developed US bond market. Greater sophistication is being demanded from vendors to ensure they can support the greater levels of scrutiny expected by clients. In the current climate, the risk of valuation error has heightened, and therefore the vendors will be expected to react more responsively to shifts in the market. Vendors need to be equipped to deal with the greater demands for transparency and valuation accuracy.

Ciccotto: Standard & Poor’s has taken a conservative approach to the expan-sion of asset-class coverage, and we have maintained a market approach to pricing. Critical to our approach for expansion is

the ability to secure ongoing reference data, availability of market data inputs, experi-enced pricing analysts that can interpret, manage and react to these inputs, and the ability to integrate these new asset classes into our current workflow, processes, pric-ing systems and oversight procedures.

Swain: Perhaps. At StatPro we have found it tempting to offer what our clients have asked for. Instead of blindly jumping in, however, we have focused on quality and value. Focusing on providing consis-tently accurate valuations in the tradi-tional space, and expanding into relatively few new areas such as money market valu-ations and simple derivatives, has allowed us to retain the confidence of our existing clients, while still allowing us to increase our penetration and grow our business. Our overriding focus is on reliability, qual-ity, and transparency in what we deliver.

Mackelburg and oldham: Customers depend on pricing services, and when market conditions are stressed, they rely on them more, especially when they do not have the internal resources to perform quality control work. Pricing is not just about coverage but about supporting the timely turnaround required for end-of-day valuations, and we are increasingly seeing customers wanting to work with us to more effectively integrate their pricing workflow with ours. Working together in this way brings benefits to the customer in the form of more efficient and focused pricing activities.




Do You Have a Firm Grasp on the Value of Your Holdings?Sponsor’s Statement

Transparency is fundamental to the valu-ation process. Investors and regulators expect consistent, transparent and fair pric-ing across a range of fixed-income securi-ties and alternative investment classes

Independent evaluations of fixed-income securities and valuations of complex OTC derivatives and structured products are seeing increased demand as a result of a combination of new regulations, market vola-tility and the credit crunch. Evaluations can serve as valu-able inputs that can be used by clients to reduce the time, cost and effort associated with their portfolio valuation process and can also help institutions comply with regu-lations and accounting standards.

This demand looks set to continue, with financial institutions still seeking to invest in new, more complex financial instru-ments to diversify their portfolios and grow their business in these difficult times. The growth of alternative investment funds and the opportunity for asset managers to invest in derivatives under UCITS III, for example, has led to exponential growth not only in volume traded, but in levels of complexity.

Continued turmoil in the financial markets has resulted in the implementation

of stronger risk management frameworks. From MiFID to Reg NMS, IAS 39 and UCITS III, new regulations, standards and directives have impacted the industry with new compliance processes and procedures.

The Financial Accounting Standards Board’s FAS 157 has had a major impact on demand for independent evaluations; firms have had to review existing valuation policies and procedures, and develop proce-

dures for fair-value disclosures in their financial statements.

To help clients prepare for FAS 157, Interactive Data has developed a set of

informational resources aimed at providing clients with increased transparency into its evaluations by disclosing the types of inputs by asset class used to prepare evaluations. This ‘bucketed approach’ was designed to provide clients with enough information to establish their own fair-value hierarchy determinations as required under FAS 157. Recent additional informational resources, including a daily market commentary that reflects activity in the US fixed-income markets as of mid-day, are designed to help clients better understand Interactive Data’s evaluations and the impact daily market conditions may have on these evaluations.

“FAS 157 has had a major impact on demand for

independent evaluations” Shant Harootunian


Valuations of complex OTC derivatives and structured productsInteractive Data also provides valuations of highly complex OTC derivatives and structured products through an exclusive agreement with Prism Valuation. Prism Valuation—whose philosophy to valuation is built on three pillars ‘people-data-models’ —provides services that replicate the pric-ing and risk analysis capabilities of a struc-tured products dealer, with an emphasis on hard-to-value assets.

The service can provide valuations on a daily, weekly, monthly or quarterly basis for most flavors of OTC derivatives and complex securities, with new structures continually being added. Clients are able to submit deal confirms or other source documents directly, rather than having to input the structure and select and calibrate models themselves.

A key feature of the service is a Valuation Transparency Report, in which the valua-tion process for even the most complex structures is explained in plain language. This includes the choice of underlying market data, appropriate model selection and calibration strategies culminating in a valuation. A further value-added analysis available on an ad hoc request basis is a detailed Valuation Discrepancy Report,

which compares any differences between a customer’s valuation (counterparty and/or internal valuations) and the Prism Valuation service.

Against the background of new regula-tions and market volatility, financial insti-tutions need to ensure they have a firm grasp on the value of their holdings—espe-cially thinly traded fixed-income securities. Independent evaluations and valuations of complex instruments are critical inputs to the portfolio valuation process and can deliver significant value to financial institu-tions during these turbulent times.

Shant Harootunian is managing

director, evaluated services, Interactive Data Pricing and Reference Data

www.interactivedata.com

Do You Have a Firm Grasp on the Value of Your Holdings?

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Interactive Data Corporation (NYSE: IDC) is a leading 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


Sponsor’s Statement


Managing Valuation Risk in the New Financial LandscapeThe new financial landscape demands intense focus on the quality and integrity of valuations, as well as understanding the underlying methodologies, assump-tions, and inputs for pricing models. Market participants must have confidence that valu-ation risks are well understood in a highly interconnected investment environment and that they are consistently treated across the enterprise. Performing this on a timely basis is a major organizational concern.

The cornerstones of effectively func-tioning financial markets are a massive reliance on data, financial models and the processes by which they are combined. In recent years, those building blocks have been tested as never before. Financial innovations have included high levels of leverage, complex instruments, and sophisticated algorithmic models in the quest for alpha-generating investment strategies and accurately slicing up risks to match required return profiles.

Financial models are used to measure economic performance. Yet models rely on assumptions and are usually calibrated for a given set of market condition scenarios within the financial ‘ecosystem’ for which they were designed. Assumptions behind some recent innovations have now proved

to be flawed. Credit default swap prices and the ABX index proved to be unreliable proxies for valuing underlying corporate or asset-backed securities (ABS) instruments, as counterparty and liquidity risk over-whelmed underlying credit risk. Investment-grade ratings on securitized products do not have the same characteristics as corpo-rate credit ratings and did not adequately reflect the impact of falling home valua-tions and a spiral of mortgage defaults. Perspectives of price and fair market value

diverged in illiquid and distressed markets.

What has proved partic-ularly devastating in this current environment has been the increased inter-connectedness of events. Leverage and securitiza-

tion have been instrumental in this. The speed of market events and recycling of risks combined with increased reliance on machines for trading and reduced human oversight meant that when the bubble burst in the global economy, extreme scenarios became realities, which quickly turned into a runaway train. For example if 80% of European CDOs invest in the same issuer and the ability to effectively monitor that exposure is limited, diversification assump-tions can prove to be badly wrong.

From every disaster comes an opportu-

“The cornerstones of effectively functioning financial markets are a

massive reliance on data”William Hickson



nity. This is one of the most exciting periods in the financial markets’ history, which will (hopefully) not be repeated. Making the right choices for strategic data investment now will help determine the winners of the next cycle in financial markets.

Market participants require fair and transparent valuations of financial instru-ments from independent, unbiased third parties. Thomson Reuters Pricing Service works directly with clients to ensure market challenges are addressed on a timely same-day basis. The pricing service includes multi model approaches for complex securities to provide customers with all the information they need to gain assurance on the quality of a price. The models used are transparent and available for scrutiny by clients and auditors. Thomson Reuters is also identi-fying opportunities with a number of clients to align pricing and quality assurance activ-ities to remove duplicative processes across vendor and customer.

Financial institutions must also plan to increase the consistency and integrity of market data across pricing and refer-ence data, and increase integration of counterparty and trade data to better support risk management and compliance processes. These are complex challenges and require the right foundations to support a longer-term resilient solution and an end-to-end view of data management.

Thomson Reuters offers ‘Intelligent Information.’ It reflects the approach to building intelligence into information that can better serve the client’s needs in a highly connected and competitive arena. Behind it is significant investment in capabilities such as symbology management, metadata, counterparty data, search technologies and semantic news information that helps better describe in machine-readable forms the connectedness that exists in today’s finan-cial markets.

William Hickson is head of Evaluated Pricing and Structured Finance at

Thomson ReutersTel: +1 646 822 4800

www.thom-

Managing Valuation Risk in the New Financial Landscape

Thomson Reuters’ pricing and reference data services are available through the DataScope product suite and include:• Evaluated intraday and end-of-day prices for the fixed-income universe of bonds and structured products• On-demand pricing of OTC derivatives and other complex securities• Comprehensive fixed-income terms and conditions• Corporate actions data• Counterparty data



How has the financial crisis affected the focus on independent evaluations? The credit crunch has brought attention to the opaque nature of the many fixed-income products that are traded. From 2003–2007, Wall Street created a number of complex and illiquid securities, such as CDOs, CDO2, CDSs, for willing investors in search of an extra basis point. As such, many securities owners were lulled into believing markets were, at best, forever upward trending, or at worst, forever stable. Many of these securi-ties or derivatives have embedded options or arcane cashflow waterfalls that can make valuations virtually impossible. Therefore, the reliance on internally generated valua-tions (ie, mark-to-model)—especially illiquid issues—became the freight train running headlong into investors and regulators. In this environment, independent evaluations carry great weight.

What changes could regulation make? Market participants, regulators and private interests alike, are all in search of trans-parency. In this regard, one-sided valua-tions—internally generated or single-dealer derived—are no longer tolerable. Any third-

party valuation should be viewed in addition to any internally produced figures or dedicat-ed singular sources. Any model-driven valua-tions will also need to provide the underlying assumptions. Also, if the use of proxies are employed, holders of securities will need to justify the proxy.

How has the crisis changed any hopes you have for this space in the future? There is a need for increased transparency, especially for assets such as mortgages and other structured products, as the market is grappling with their values. A further chal-lenge has been created by the number of major dealer firms disappearing, such as Lehman and Merrill Lynch. As such, there will be fewer sources from which to survey valuations and prices.

How well do you think firms are deal-ing with evaluation risk? Firms are handling the situation as well as they can. Once a firm is long securities that become distressed, it must provide as many different approaches to valuation to regula-tors as possible. Having independent evalu-ations must be a part of that recipe.

Q&A

Crunch Time

John Jay

IRD speaks to John Jay, senior analyst, Aite Group about how the credit crunch is impacting the evaluated pricing space


See through riSkTransparency is essential for managing risk in complex and volatile markets. It’s the key to dealing with the new world of scarce liquidity, amplified volatility, broader spreads and counterparty risk. Thomson Reuters provides the clarity you need. Voted ‘Best Risk Management Provider’, No. 1 Back Office System’ and ‘No. 1 Overall Technology Provider’*, we can help you see through risk and make clear decisions.

Learn more at reuters.com/risk or contact us at [email protected]

* ‘Best Risk Management Provider’ (Waters, 2008) ‘No. 1 Back Office System’ (International Banking Systems 2006 and 2007) ‘No. 1 Overall Technology Provider’ (Asia Risk 2008)

© Thomson Reuters 2009. All rights reserved. 48000250

REUTERS/CARLOS BARRIA

Incisive Media, Haymarket House, 28-29 Haymarket, London SW1Y 4RX


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