European Commission sets out technology-driven action plan for derivatives trading

I am always concerned when we try to solve our problems (or simply wish them away) by invoking “technology” as the panacea. So seeing the headline “European Commission sets out tech-driven action plan for derivatives trading” on an e-mail alert from Finextra brings to mind all the previous misguided attempts to solve everything by throwing technology at it.

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We have previous attempts to manage operational risk by “mining” historic loss data (which often did not exist in digital form anyway) and using this as an indicator of the future losses or the over reliance of VAR. Interestingly, Pablo Triana in his book “Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets?” aptly compares VAR to a passenger airbag that works only 95% of the time; unfortunately the other 5% includes the time when the driver is involved in an accident.

In dealing with Money Laundering we really threw the baby out with the bathwater when we abrogated the requirement to “Know your customer” from a real personal knowledge of who your customer was and what his business really was about to the technologists black box and the modern alchemist’s book of formulae and often erroneous suppositions.

I most certainly agree that derivatives and credit default swaps have created a web of mutual dependence that makes it difficult to understand, disentangle and contain risk in the immediate aftermath of a default. I am all for using technology to improve the situation.

However, I do really fear that unless we really have a clear understanding of the derivative practices and processes and the potential implications, throwing all this technology at it could end up as a huge waste of money.