Some would argue that it is everything that affects a business, which
is not market or credit risk. Others argue that it is everything and any-
thing to do with the post-transaction clearing and settlement process.
Another key factor in this lack of recognition is that the subject of
risk is viewed primarily in terms of potential financial loss. As such
operational risk is frequently considered to be unlikely to cause a
severe financial loss, at least not in one hit. The logic here is that an
inappropriate or incorrect deal can result in substantial loss,
whereas a settlement problem with the transaction, whilst it may
incur costs, is not likely to generate a significant loss.
History would tend to suggest that the headline-making ‘disasters’
in the financial services industry are all mainly related to market
and/or credit risk, in the sense that they involve significant positions
in derivatives where the obligations could not be met.
However, delve a little deeper and it may be that associated opera-
tions issues contributed to the problem. The contribution may not
have been ‘physical’ in the sense of an error in processing transac-
tions but rather a failure to carry out the risk management role that
the operations team undoubtedly have.
Understanding the risk sources and the impact of that risk is called
risk mapping. This involves the analysis of the workflow and the critical
tasks through the clearing and settlement process. It is also prudent to
consider any risk sources that could occur prior to clearing and settle-
ment. These would include pre-trade checks on:
• Authorised products
• Deal limits
• Position and exposure limits
• Counterparty limits
• Liquidity limits.
In addition we can include product knowledge and static data in
the list.
Some other areas in the organisation like the Credit Team and
Compliance will monitor some of these.
However, the operations area is involved in some of this risk
management process as the information produced on positions, for
example, is critical to an accurate risk management process.
Key functions such as reconciliation and error resolution must be
effective; otherwise the dealing function is hampered, or the organisa-
tion may be put at risk by ‘hidden’ positions, unauthorised exposures,
etc. As these present not only an unacceptable risk but also a breach
of regulations, the consequences are clear.
160 Clearing and settlement of derivatives