Operational Risk and Reference Data: Exploring Costs, Capital Requirements and Risk Mitigation

Abstract

New regulations are imbedding operational risk concepts and the provisioning of operational risk capital in the risk management considerations of globally active financial enterprises. Inherent in new capital calculations is the effect of losses due to faulty reference data, data which is costly to acquire and maintain, duplicative across the industry and of no strategic value, and which comprises 70% of the data content of financial transactions. Faulty reference data has been a persistent impediment to systemic risk mitigation across the global capital and investment markets. Reference data electronically represents financial products and their changing specifications, counterparties, financial intermediaries, corporations, issuers, financial markets, currencies, valuation and market prices, and associated referential information such as credit ratings and fundamental data. This paper attempts to illuminate the effect of faulty data on operating costs, operational risk and economic capital. It also points toward applying solutions that have proven to reduce costs and risk in other industries and in other segments of the financial industry. Standards for product and supply chain participants, long a staple in the retail industry, are long overdue in the financial services industry. Financial industry-wide cost sharing and risk mitigating approaches have long been organized around shared infrastructure entities but, to date, have only been applied to the value portion of transactions (principally quantities, transaction prices and amounts). This paper argues for these same techniques to be applied to the matching and "clearing" of the reference data components of these transactions. The authors conclude that data and its management is costly, averaging $740 million each for the largest financial enterprises, and that faulty data is at the core of significant components of operational losses. Finally, the authors believe that industry-wide collaborative initiatives can reduce data costs significantly, lower capital requirements and mitigate risk.

Keywords: Financial Institutions, Operational Risk, Data Management, Reference Data, Basel, Risk Management

JEL Classification: G2, G21, G18