O R O™ (Operational Risk Offset) enables financial firms to efficiently hedge their exposures to operational risks from securities and cash transactions performed in the normal course of business.

A specialist fund functions as a hedge pool to match asset and liability streams utilizing the predictive analytics in ContextMetrics™. The hedge pool is capitalized by qualified (institutional) investors who are offered a rate of return benchmarked to established market indices.

O R O™ participants (eg, custodian banks) hedge their exposures (eg, failure to process a corporate action) by securing "Participation Options" (PO) sold over-the-counter. The value of the PO's for potential purchase will be based on the risk forecast provided by ContextMetrics™ at a specific point in time (eg, a 98 percent probability of fails for a tender offer where remediation is valued at USD 0.7 million as-of two days prior to settlement). Draw-downs from the hedge pool will be made only if the O R O™ participant explicitly exercises the option to do so.

The advantages to using PO's are :

• relevance based on current risks (rather than generic a priori estimates from historical fails)
• capital-efficient since PO's are acquired only when absolutely needed
• cheaper than traditional insurance
• based on transparent and readily understood factors articulated by ContextMetrics™; and
• simplifies attribution and expense allocation to specific perils and the originating counterparty.

To minimize moral hazard, the cost of acquiring a hedge is conditioned by a 'reputation' ranking derived from :

• the frequency and severity of historical risk alerts generated by ContextMetrics™; and
• the number and magnitude of actual PO draw-downs exercised.

Note that O R O™ participants are clearly incented to improve their 'reputation' rankings and minimize their exposures to operational risk. This generates a significant emergent benefit across the securities industry that, over time, will result in more efficient operations and potentially reduced capital set-asides (especially for larger firms who utilize the Advanced Management Approach (AMA) per Basel II).

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