Digital Risk Indices – Why they matter in credit and counterparty risk monitoring


Anyone dabbling in the financial world knows that indices are a vitally important fiscal tool. They are often used by lenders and portfolio managers to track and assess the performance of their assets. Investors leverage them as a guide for devising long-term wealth strategies and economists use them to survey the economy. So, it’s no surprise then that there are literally thousands of indices worldwide that track everything from stock markets to bonds and commodity prices. And while financiers always keep a close eye on broad market indices such as the S&P 500, the Dow Jones, or the NASDAQ, there are several ‘alternate’ indices out there that can be just as beneficial to them. A Digital Risk Index is one such benchmark and is one of the metrics that TRaiCE tracks. In this blog, we explore such indices and their utility in credit, investment, and counterparty risk monitoring practices.


A businesswoman using a digital tablet with a digital risk index on screen
A Digital Risk Index uses financial contexts to identify entities experiencing business distress

What is a Digital Risk Index?

Why do digital risk indices matter?

Advantages of using a digital risk index

Some examples of the TRaiCE Digital Index in action

Conclusion


What is a Digital Risk Index?


Simply put, a Digital Risk Index is one that measures how healthy a business is using digital data. It uses financial contexts to identify companies exhibiting signs of early distress and are in need of a closer inspection. When digital data monitoring is combined with ongoing financial monitoring, the end result is a powerful tool for organizations tracking risk. Now, this is not a new concept. There are several other indices that use non-financial information as a barometer for business health and some of these have been around for decades. For example, the Consumer Confidence Index (CCI) which measures and predicts economic and business health in the US first came out in the late 1960s. Other examples of such indices are the Michigan Consumer Sentiment Index (MCSI), the NFIB Small Business Optimism Index, the Business Confidence Index (BCI), and the High-Low Index.


However, digital indices differ radically from most of the commonly available sentiment indices in a couple of significant ways. For one, most of these indices are constructed using opinion surveys that interview business owners or households. Contrastingly, the TRaiCE index gauges business health by reviewing leading-indicator data sourced from the four corners of the digital world. For another, because of the time it takes to conduct the surveys and/or collect the data needed for them, most sentiment indices are available for preview only on a monthly, quarterly, or bi-annual basis. On the other hand, the TRaiCE index is calculated continuously on a 24/7/365 basis, making it a timelier benchmark for digital health monitoring.


Why do digital risk indices matter?


In the hyper-connected and hyper socialized world that we live in, opinions and sentiments matter. It is a well-documented fact that investor sentiment can affect the stock market. This was infamously demonstrated in 2018 when spooked investors put off by rising interest rates, the US government shutdown, and tariff wars with China dumped stocks causing US stock market indices to drop to a 10-year low.


Similarly, in the online business world, the court of public opinion can sometimes be harsher than an official inquiry. Viewpoints, especially those expressed by influential characters can impact a company’s present and future growth prospects. A classic example of this is a 2016 tweet by Tesla CEO Elon Musk announcing an exclusive battery-procuring partnership with Panasonic. The tweet caused shares of Samsung SDI (a rival battery-making subsidiary of Samsung) to plunge by 8%. As a result, the company lost over half a million dollars in just one day.


And it's not just the rich and powerful who can move mountains in the business world. Who can forget how a bunch of individual Redditt traders caused shares of GameStop, a struggling video game retailer, to skyrocket in the David-Vs-Goliath-like GameStop saga of 2021. The actions initiated by these average investors almost single-handedly revived the company’s fortunes and stopped it from going out of business.


Admittedly, the above examples fall on extreme ends of the spectrum and such dramatic changes to business fortunes do not usually happen every day. But they are a true representation of the power of digital and social media and a microcosm of the unique challenges that come with being a 21-st-century business. Fortunately, what is a challenge for some is an opportunity for others. Digital media today is awash with alternate business information that can give a sneak peek into a company’s health and creditworthiness. There is also a growing body of work that suggests a correlation between business health and digital sentiment. This is something a financier can and should take advantage of.


Information, an asset in most industries, is a crucial commodity in the financial world. Timely data can often help financiers make prudent investment decisions and digital data is the timeliest of them all. So, when there is so much actionable intelligence to be gained here, why not leverage it? The problem with web data is that there is a veritable ocean of it, making the process of digitally analyzing counterparties a particularly tedious one. This is where digital indices come into the picture. They help financiers leverage the information age that we live in without putting in the extra effort that this exercise demands.


Advantages of using a digital risk index


Real-time analytics


Traditional credit and asset monitoring practices rely heavily on quantitative or financial assessments of their counterparties. The problem with this methodology is that it uses data that is usually weeks or months old. This in turn results in risk profiles that are perennially outdated. Since digital indexes use real-time or near-real-time data in their index calculations, you get risk profiles that are up to date and reflect market fluctuations or sudden changes in company fortunes much quicker.


Anticipate future events better


Financial metrics are lagging indicators that only reflect past events. As such, they are good indicators of past creditworthiness, but poor predictors of future growth. To predict future business health, financiers should include leading indicator information in their risk assessments. Some examples of such leading indicators include metrics such as a business’s customer loyalty, brand image, or online reviews. These are better indicators of how the business will perform in the future than past or current financial performance. Digital data hides such crucial non-financial information, allowing you to anticipate future events better.


Quantify and measure non-financial data


The financial world is driven by numbers. As management guru Peter Drucker famously said, ‘If you can’t measure it, you can’t manage it.’ So, perhaps one of the biggest drawbacks of digitally examining your counterparties (aside from it being a very time-consuming exercise) is that there is no way to quantify the process. Digital indices take care of this problem by measuring each counterparty’s business health and assigning a numerical value to it. This in turn makes it easier for you to compare different assets, competitors, and counterparties.


Get the complete picture


Financial distress is not the only risk financiers need to worry about while monitoring their assets or counterparties. Other risks such as operational, environmental, and reputational ones can cause just as much harm (for more details on this, check out our blog on comprehensive counterparty monitoring). It is therefore a good idea to monitor both financial and digital data for signs of upcoming distress if you want a complete picture of your entity’s business health.



Some examples of the TRaiCE Digital Index in action


Actions speak louder than words. Accordingly, we have a selection of companies below that showcase the value of including the TRaiCE Digital Index in credit, asset, and counterparty risk monitoring practices. Due to the proprietary nature of the information, we cannot reveal any specifics. However, if you are interested in knowing more about these case studies, please feel free to reach out to us at info@traice.io for more details. You can also read our in-depth case study on the Greensill bankruptcy and the leading indicators that investors ignored. Without further ado, here are some examples:


Example 1: Hin Leong


Hin Leong is a decades-old Singaporean oil trading company. In April 2020, the company defaulted on its loans causing its lenders to freeze credit lines. An investigation into the company’s financials revealed many fraudulent practices and the whole saga ended with Hin Leong filing for bankruptcy and its founder O.K. Lim being saddled with charges of forgery. TRaiCE picked up signs of business distress in January 2020 with its digital index showing negative values from then on. Importantly, this was three months before the company’s troubles became common knowledge.


Example 2: Chuck. E. Cheese


The iconic American family entertainment business filed for bankruptcy in June 2020. In the months preceding this, the company battled reputational losses that came their way when several YouTube and social media stars spoke out against the company’s alleged unhygienic practices. This along with the losses stemming from the Covid-19 pandemic proved too much for the business to handle. TRaiCE picked up on the company’s calamities 6 months before it entered bankruptcy proceedings.


Example 3: Paper Source and J Crew


J Crew, a prominent American apparel company filed for bankruptcy in May 2020. Paper Source, a stationery and gift chain established in 1983 did the same in March 2021. TRaiCE identified business distress for both these companies much before their eventual collapse. This is reflective of the growing debt pile, plummeting sales numbers, and increased store closures that were reported online.


Example 4: Luckin Coffee


Luckin Coffee is a Chinese coffee company that was founded in 2017. With its flashy marketing campaigns and rapid expansion, it was the darling of the startup world. The company however went from hero to zero in February 2021 when it filed for bankruptcy in the US. The fall was precipitated by the discovery of accounting fraud in April 2020. TRaiCE revealed this with a dramatic drop of over 30 points to the digital index it tracked for the company.



Conclusion


The digital world is not just a place where trolls and armchair psychologists thrive. It is also a place where you can get a rational and timely, though unconventional, assessment of your counterparties. Some of these assessments may be by experts and some by the average Joe. No matter the source though, they do hold the power to shape business destinies and, therefore, should not be ignored. This is especially true given that the uncertainty of present-day financial markets sometimes makes past financial data null and void. The TRaiCE digital index helps financiers do just that. It helps them leverage the golden age of data that we live in while giving them an added layer of risk protection.





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