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XML in the financial services industry: applications of the standards. (Finance).

Article Excerpt
The financial services industry spends billions of dollars on IT development to maintain its competitive edge. Banks, risk management firms, and insurance companies have been focusing on XML as a means to exchange their data and to streamline the trading, settlement, and risk management processes. In light of such goals, industry consortiums have been signaling their commitment to XML by creating XML standards for data exchange.

This article will discuss the application of XML in building a risk management system. Topics covered include FpML (Financial products Markup Language), how to extend XML standards, XML Key/KeyRef for referenctial integrity, XQuery, and Web services.

I will explore the application of FpML using a case study on building a corporate risk management system. Currently, FpML is used internally by a large number of prominent financial institutions for their risk management and derivatives systems. It is one of the key standards used in financial services along with FIX (Financial Information Exchange protocol). This case study will illustrate how FpML is used in the different steps necessary to build a successful risk management system.

The Risk Management System

Financial institutions such as Citibank and JPMorgan Chase trade in many different markets across the globe. Each trading department keeps track of how much it has invested and how sensitive the investment is to changes in market conditions. For instance, say the Hang Kong office invests $30 million in a financial security such as a currency derivative. The contract is structured in such a way that if interest rates rise by 0.1%, it will lose $10 million. Or say the Hong Kong office holds a contract with a firm whose credit rating has fallen to DDD, according to Standard & Poor's. If it does not get out of the contract soon, the office runs a credit risk of losing $7 million in case the counterparty cannot pay its part of the agreement. By closely monitoring market and counterparty conditions, each local office calculates the quantitative risk it takes by conducting sophisticated statistical tests that return risk metrics and allow it to change its trade position if required.

Similarly, the Dubai, London, and Buenos Aires offices conduct the same analysis for theft investments. For each local office, this is a very good way of managing risk. However, it's potentially dangerous when you consider the situation in which all four offices will lose $10 million each if interest rates go up by 0.1%. That kind of loss can bankrupt a small firm. Hence the need for corporate risk management.

A corporate risk management system keeps the aggregate trading positions of all its domestic and overseas offices and runs analytics to monitor the risk exposure of the firm as a whole and ensure that it doesn't exceed a conservative threshold. In other...

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