Transcript Folie 1

Challenges in Market and Counterparty Risk
Management
How to solve the critical issues? Solutions that can help.
Reinhard Keider; Head of Risk Architecture and
Risk Methodologies in Bank Austria
ZADAR, 14 May 2011
Don´t ever try to understand everything,
some things will just never make sense.
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I guess some of you might agree with this saying.
Despite this I will try to
1) Make my brief presentation understandable
2) And hopefully it make sense to you.
….so let´s start !
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AGENDA
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
Part 1: Market Risk Management
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Part 2: Counterparty Credit Risk

Part 3: New regulatory framework (Basel 2.5/3)
Part 1: Market Risk Management
Market Risk Management must be seen as an integrated approach.
Successful Market Risk Management should cover at the least the following
topics:
 Risk Management Unit to be independent from business unit
 Consistent framework where to operate (RM handbook, clear and
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transparent limit structure, Escalation path in case of limit violation)
Combination of limits: VaR limits, sensitivity limits, options limits
State of the art model for monitoring/steering market risk (internal model
internal/external)
Coverage of the relevant instruments/products
Consistent Market data, risk factors and time series
Flexible architecture to include new products fast and efficient
Experienced people within Risk Management Unit
Components of MR Management
 Dependent on asset classes within the bank a market risk tool needs to
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cover FX products, Interest Rate Instruments (both linear and non linear
ones), Equity and Credit Spread linked instruments. Currently commodity
and inflation linked products need to be covered properly.
The number of Risk Factors plays important role to reflect a realistic risk
picture (e.g. FX: 75 currencies, 45 IR curves, 5000 EQ, 250 Spread Curves,
Vega risk: 2000 risk factors)
State of the art modelling in terms of simulation; Historical simulation, Monte
Carlo Simulation for monitoring/steering market risk (internal model
internal/external)
Stresstesting: importance still increasing; standard scenarios and macro
economic scenarios (e.g. Greece default, inflation, terror attack)
Export /Transfer module and data source module allow fast integration of
new requirements
Reporting engine to fullfill various information needs
Backtesting gives answer about to model qualtiy
Comparison of current and new Market Risk Capital
Requirements for Trading Book
Current Approach
New Approach
Value-at-Risk based capital
charge
Value-at-Risk based capital
charge
Specific Risk Surcharge
+
(capture default risk)
+
Incremental Risk Charge (IRC)
+
Stressed VaR
+ CRM for correlation trading
+ Capital from standardised
approach
portfolio
+ capital from revised
standardised approach
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Part 2: Counterparty Credit Risk (CCR)
Basic definition, types of CCR

Counterparty Credit Risk (CCR) is the risk that a counterparty to
financial contracts fails to fullfil the obligations (payments, delivery of
assets) agreed in the contracts.
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Two types of CCR are distinguished
1. Settlement Risk:
The counterpary fails in setteling its due payments or deliveries
2. Presettlement Risk
The counterpary defaults before contract settlement
Following products are subject to CCR:
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OTC-derivatives (no exchange-traded instruments)
Securities Financing Transactions (SFT)
(e.g. securities borrowing and lending, repurchase and reverse repurchase
agreements)
Why to introduce an internal model for counterparty
credit risk? Key benefits?
 Improvement of Internal risk management:
 A state-of-the-art model allows realistic assessment of actual counterparty credit
risk exposure
 Allows efficient use of credit lines by supporting risk mitigating effects:
 Full Netting effect
 Margining
 Portfolio effects
 Capital calculation:
 Same risk mitigation effects as for internal risk management apply
 Usually Significant RWA reduction compared to Current Exposure Method to be
expected
 Risk adequate pricing:
 Unilateral/Bilateral Credit Valuation Adjusments supported, taking full portfolio
view into account
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Counterparty Credit Risk
Aspects of Managing Counterparty Credit Risk
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means of CCR
management
and control
description
measure and
limit counterparty
exposures
Internal Limits:
 measure CCR and link exposure limits to CP credit grade
 take advantage of risk mitigation techniques - use netting,
margining, break clauses, reset agreements
hold capital for
counterparty
exposures
RWA (Risk Weighted Assets):
 measure Exposure at Default as underlying for RWA
following Basel 2 Internal Model Method (IMM)
 enable bank to absorb unexpected CCR losses during
downturn periods
counterparty risk
sensitive
customer pricing
CVA (Credit Valuation Adjustment)
 pricing of OTC contracts subject to CCR should reflect the
default risk
 fair value adjustment of risk-free prices for counterparty risk,
 hedge against CVA-induced P&L variations
Coverage in
Bank Austria
Pre-Settlement
Risk Limit
Exposure
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Basel 2 IMM
Exposure-atDefault
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Credit Valuation
Adjustment
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Quantitative measures for CCR
Exposure measure and purpose
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Exposure Measure
purpose of application
Current Positive Exposure (CPE)
equal to the current replacement cost of a
transaction
Potential Future Exposure (PFE)
maximum exposure estimated to occur on a future
date at a high confidence level
 used for counterparty credit limit
Expected Positive Exposure
(EPE)
• credit equivalent input for risk capital calculation
(regulatory and economic)
• input for cost calculation
• EPE profile input for Credit Value Adjustment (CVA)
• closely related to EE (Expected Exposure)
Internal Counterparty Risk Model
Model overview and components
Transaction
data
Product valuation models
Market data
Spot rates
Vanilla options (Black
Scholes)
Yield curves
Swap rate
etc.
Capital
requirements
 Collateral
data
Country
Credit
Valuation
Adjustment
etc.
Reporting
Maturity
Swaption, cap/floor
etc.
etc.
Limit
monitoring
 Netting
data
Settlement
frequency
Barrier (standard,
double)
Risk Management
Legal
agreements
Reference
rate
Exotic (accrual,
extendable)
Volatilities
Counterparty
data
Stresstesting
Validation
Market data pre-processing
Aggregation
Scenario engine
Instrument price distributions
USD interest rates
Value of swap (% of notional)
20
6.0%
Limit
15
5.0%
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Exposure
USD interest rates (%)
7.0%
4.0%
5
3.0%
0
2.0%
0
1.0%
-5
0.0%
-10
0
2
4
6
Time
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Output
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10
1
2
3
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EE
PFE
Reduction)
5
0
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Time
2
4
6
Time
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Part 3: Basel 2.5 and Basel 3
Chapter Title - Chapter Section Title
Challenges to the Banking industry in front of
new Basel regulations
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Current situation (Basel II)
• VaR
based Trading book capital charge calculated using 99%
quantile of 10 day loss
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Common assumption:
Losses from issuer defaults in trading book positions negligible since
– Mainly high rated issuers in trading book
– Positions are sold in case of downgrading
Financial crisis:
• Losses >> trading book capital charge occurred
(e.g. Lehman Brothers)
• Particularly positions subject to credit spread risk (cds,
cdo,bonds,…)
• Significant part of the losses not caused by actual defaults but by
rating migrations
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Regulatory Response
Basel Committee proposed changes to the capital requirements for
the trading book: (mainly for internal model)
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Incremental risk charge (IRC), specific risk
Stressed value-at-risk, general risk
Comprehensive risk measure for correlation trading activities
For remaining securitization products the capital charges of the
banking book apply
Implementation date: 31 Dez. 2011
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Timeline for Basel 2.5 and 3
Dec. 2009
Basel III first draft,
‚Strengthening the
resilience of the banking
sector‘
…July 2009
Basel 2.5 proposal
Finalised June 2010
IRC, CRM, Stressed VaR,..
Dec. 2010
Basel III ~finalized
‘A global regulatory
framework for more resilient
banks and banking systems’
Jan 2013
Initial rise in capital
from Basel III
Stressed EPE,
Market Risk CVA charge,..
Dec. 2011
Basel 2.5 goes live
IRC, CRM, Stressed VaR,..
Leverage ratio
Liquidity ratio ..
Final implementation
2019
Basel Reform Programme: Focus on Counterparty Credit
Risk - Overview
A. Capital Base
B. Counterparty Risk
C. Leverage Ratio
D. Procyclicality
E. Liquidity Standard
Raise quality, consistency
and transparency of bank's
capital base
Strengthen risk coverage,
amending July 2009's
trading book and
securitization reforms by
adding capital
requirements for
counterparty credit risk
Introduce a "leverage ratio"
as a supplementary
measure to the Basel II
framework with in order to
build up excessive
leverage in the banking
system
Promote measures for
building up capital buffers
in good times that can be
drawn upon in stress
periods
Promote measures for
building up capital buffers
in good times that can be
drawn upon in stress
periods
EXAMPLES
 Determine capital requirement for counterparty credit risk using effective EPE calculation for a period
of stress (similar to 2009' proposal regarding market risk stressed VaR) and
 Introduce captial charge for mark-to-market losses (ie credit value adjustment losses = CVA risk)
associated with deterioation in the credit worthiness (not necessarily default) of counterparties
 Strengthen standards for collateral management and initial margining. Eg banks with large and illiquid
derivative exposures will have to apply longer margining periods.
 Banks with exposure to central counterparties (of those are meeting some CPSS/IOSCO "strict criteria"
only) will qualify for a zero percent risk weight.
 Include "wrong-way risk" (cases where the exposure rises when the credit quality of the counterparty
deteriorates) into Pillar 1 requirements, enhance stress test requirements, revise model validation
standards and issue supervisory guidance for sound backtesting practices of CCR.
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Additional Market Risk Capital Charge
Credit Valuation Adjustment: Cover MtM of unexpected
counterparty risk losses
 In addition to the existing capital charge for unexpected losses arising from
counterparty defaults (Counterparty Credit Risk RWA) a stand-alone capital charge has
been proposed to cover the market risk of potential MtM losses due to spread driven
increase of unilateral credit value adjustments (CVA) of OTC portfolios.
 Unilateral CVA: Adjustment of the risk-free mark-to-model prices of OTC derivatives for
the credit risk of the counterparty (= expected loss).
 Calculation of the new CVA capital charge by evaluating the unexpected losses of a
portfolio composed of bond-equivalents each describing the OTC exposure to a
counterparty and associated hedges.
 Applying the applicable regulatory market risk charge (IMOD) to the bond-equivalents (i.e.
99% VaR: general + specific risk including stressed VaR but not IRC).
 Liquidation horizon = 10 days
 recognises hedges: eligible, single-name CDS / CCDS or other hedging instrument directly
referencing the counterparty
 Central Counterparties (CCP) and Securities finance transactions (SFT) are excluded
 CVAs already recognised by the bank as an incurred write-down, can be used to reduce the
Counterparty Default Risk capital charge (no “double counting”)
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Now it´s up to you to decide:
1) Was the presentation understandable ?
2) Does it make sense ?
….in any case: it is the end! 
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Many thanks for your attention !
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