Transcript HAL ORG

The Role of XBRL Based Solutions in
Best Practice Enterprise Wide Risk Management (ERM)
and Associated Risk Reporting
April 27,2005
Dr Robert M. Mark
Black Diamond &
Hitachi America, Ltd.
Overview of Presentation
XBRL based solutions can help a Chief risk Officer (CRO)
stay on top of a complex combination of “Characteristics”
which are at the core of Superior Enterprise Wide Risk
Management (ERM) solutions.
XBRL based solutions can help in proactively managing risk
on an integrated portfolio basis covering market risk, credit
risk and operational risk.
XBRL based solutions can also help to make risk
transparent.
XBRL based solutions are highly applicable for credit
analysts, equity analysts, fund mangers as well as
commercial and industrial corporations.
XBRL based solutions are also helping to satisfy the
requirements associated with the basic pillars of BASEL II as
well as SOX 404 related requirements.
Hitachi CONFIDENTIAL
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Dr Robert Mark 2
Enterprise Wide Risk Management
XBRL based solutions can help a Chief risk Officer (CRO)
stay on top of a complex combination of “Characteristics”
which are at the core of superior ERM solutions
The ability to efficiently
integrate all the components of
risk on a portfolio basis as well
as to effectively operate in
complex markets
While serving customers as
well as satisfying regulators is
a direct function of the quality
of the policies, methodologies,
and infrastructure
Regulators
Rating Agencies
Equity Analysts
Hitachi CONFIDENTIAL
Customers
Investors
Financial Risk
-Market Risk
-Credit Risk
Non Financial Risk
-Operational Risk
-Business Risk
Markets
Methodologies
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 3
Enterprise Wide Risk Management
XBRL solutions can help in proactively managing risk on an
integrated portfolio basis
XBRL solutions can help at each of several layers of
functionality
= Portfolio
Mgmt
+ Performance Measurement
+ Facilitate Loan Pricing + Approving Deals
+ Accounting Capital
Capital
+ Economic (Risk) Capital
Management
+ Regulatory Capital (Basel)
+ Setting Provision (EL)
Risk Analysis
+ Stress Test & Scenario Analysis
+ Value at Risk
+ Monitor, Identify & Avoid
Limit Management
Superior ERM Solutions
Hitachi CONFIDENTIAL
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Dr Robert Mark 4
Enterprise Wide Risk Management
XBRL based solutions can help to make risk transparent.
Failing to adopt superior ERM solutions has been costly.
Major breakdowns in board related risk governance at complex
risk-taking organizations such as at banks, securities firms,
insurance entities, hedge funds, and energy companies
Large and well documented losses have occurred in firms such
as at Bankers Trust, Metallgesellschaft, Barings, LTCM, Enron,
etc.
Significant failures to detect accounting related errors such as at
AIG and FNMA
Hitachi CONFIDENTIAL
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Dr Robert Mark 5
Applicability of XBRL
Loan and credit analysts in banks could use these
tools to evaluate commercial loan applicants.
Fund managers could use these tools to evaluate
risk profiles of companies making up an
investment portfolio.
Equity analysts and financial analysts could use
these tools in making a Buy / Hold / Sell
recommendation.
Commercial and industrial corporations could also
use these tools to position their company relative
to their competitors when meeting with the
financial analyst community
Hitachi CONFIDENTIAL
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Dr Robert Mark 6
Applicability of XBRL
Public companies that are working to satisfy the requirements
associated with the basic pillars of Basel II and / or SOX 404
related requirements (3rd pillar) could use these tools as well
Three Basic Pillars
Minimum
Capital
Requirement
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Supervisory
Review Process
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Market
Discipline
Requirements
Dr Robert Mark 7
Background
The 1988 Capital Accord was highly deficient
A one size fits all approach
Is not risk sensitive at the counterparty level
Does not recognize portfolio effects
Capital charge based on a proxy for credit risk – does not
differentiate among other forms of risk
Capital charge being a function of the type of claim – sovereign,
bank, others, rather than economic credit risk
Paradigm underpinning the capital requirement not explicit
Did not encourage investment in superior risk management
Hitachi CONFIDENTIAL
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Dr Robert Mark 8
Background
Basel II Capital Accord is a significant improvement
Encourages investment in superior risk management tools (such
as having an XBRL capability)
Broad coverage of all forms of risk
Menu of approaches from the least sophisticated to the most
sophisticated
Wide scope: Includes Banks and Securities Firms
SEC allows Securities Firms to “Opt-In”
Capital being risk sensitive
Enhances reputation of those banks that achieve approval for most
advanced Internal Ratings-based (IRB) approach
Potential of positively (or negatively) impacting credit ratings
Hitachi CONFIDENTIAL
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Dr Robert Mark 9
The Internal Ratings-based Approaches
The Foundation Internal Ratings-Based (IRB) Approach
The Advanced Internal Ratings-Based (IRB) Approach
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The Internal Ratings-based Approaches
The Foundation Internal Ratings-Based (IRB) Approach
The Advanced Internal Ratings-Based (IRB) Approach
Hitachi CONFIDENTIAL
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Dr Robert Mark 11
The Advanced IRB Approach
The Advanced IRB approach requires statistically
accurate measures of the credit risk drivers to obtain
regulatory approval, such as
Exposure at Default (EAD)
Probability of Default (PD)
Loss Given Default (LGD)
Effective Maturity (M)
Hitachi CONFIDENTIAL
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Dr Robert Mark 12
How XBRL Can Help?
For example, XBRL tools can help in collecting the necessary information to support
the Credit Risk Analysis Process necessary to satisfy Basel II.
Financial Analysis is the first step of a nine (9) step process to arrive at a credit grade.
Market Info
(eg stock Prices)
Dynamic
Obligor
Grade
Facility
Grade
123456789
Our Demo
Fundamental
Analysis
Analytics
(eg Merton Model)
Static
Financial Info
(eg EBIT)
Hitachi CONFIDENTIAL
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Dr Robert Mark 13
How XBRL Can Help?
The 9 Step Process
5 steps associated with Obligor Rating (for purposes of
predicting Probability of Default)
Financial assessment
Quality of management
Borrower’s absolute and relative position within the
industry
Quality of financial information
Country risk
4 steps associated with Facility Rating (for purposes of
predicting Loss Given Default)
Examining third party support
Factoring in the maturity of the transaction
Review of the structure of the transaction
Assessment of the collateral
Hitachi CONFIDENTIAL
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Dr Robert Mark 14
How XBRL Can Help?
The IRB system is the primary tool to set Provisions and Capital since it derives the
calculation of Probability of Default (PD) and Loss Given Default (LGD) on a
transaction basis.
Collateral
Transaction
Structure
Maturity of
Transaction
Facility
Rating
(LGD)
Third Party Support
Managerial Capability,Competitive Position
Quality of Financial Information, Country Risk
Financial Assessment
(Floor on obligor rating)
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Obligor
Rating
(PD)
Dr Robert Mark 15
How XBRL Can Help?
XBRL solutions can support both the IRB system as well as the mathematical
models such as Merton’s Model (which requires a detailed understanding of the
Balanced Sheet) which is used to predict PD.
Assets Value


2
VT  V0 exp m  2
T   TZ T
Distribution
of asset
values at
maturity of
the debt
obligation

E(VT)=VOemT
VT
V0
F
Probability of default
T
Hitachi CONFIDENTIAL
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Time
Dr Robert Mark 16
How XBRL Can Help?
Regulators will not approve the risk driver (such as PD) unless it passes the use test,
e.g. to predict Expected Loss (EL)
1. What is the probability of a
counterparty going into default?
“Probability of Default”
=
PD
X
2. How much will that customer
owe the bank in the case of
default? (Expected Exposure)
“Loan Equivalency”
(Exposure at Default)
=
EAD
X
3. How much of that exposure
is the bank going to lose?
Hitachi CONFIDENTIAL
“Severity”
(Loss Given Default)
© 2005 Hitachi America, Ltd. All rights reserved.
=
LGD
Dr Robert Mark 17
How XBRL Can Help?
Setting Provision Levels is an important outgrowth of XBRL related input to the IRB
system.
Product
IRB Rating
Client type
PD
What is the
probability of default
about the obligor?
obligor
Hitachi CONFIDENTIAL
Limit
x
Utilization
EAD
What is the risk
exposure at this
moment?
Collateral Value Collateral Category
x
LGD
=
EL
How much is the
loss at this default?
transaction
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 18
How XBRL Can Help?
Setting Capital Levels is also an important outgrowth of XBRL related input to the
IRB system.
Calculation of Capital under Standardised Approach
x
Exposure
EAD
x
BRW
x
Risk Weight
LGD
+/-
x
Correlation
Adjustment
x
8%
=
Capital
Requirement
8%
=
Capital
Requirement
BRW:
PD:
LGD:
EAD:
PD
Benchmark Risk Weight
Probability of Default
Loss Given Default
Exposure at Default
Calculation of Capital under IRB Approach
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 19
How XBRL Can Help?
XBRL capabilities enable the user to access
information of practical interest to credit
analysts. These include:
Balance Sheet
Income Statement
Cash flow
Financial Assessment Measures (e.g. Solvency,
Liquidity, and Leverage)
Key Operating Ratios
Industry Sector Analysis
Company Tier Analysis
Hitachi CONFIDENTIAL
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Dr Robert Mark 20
How XBRL Can Help?
The first step of the credit rating process typically
focuses on three key categories of ratios –
Solvency, Liquidity, and Leverage.
A user can focus on any desired category for
purposes of financial profiling.
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 21
How XBRL Can Help?
XBRL users can analyze a wide variety of key
ratios that drive benchmark analysis. The major
ratios aligned against credit rating include
1.
2.
3.
4.
5.
6.
7.
8.
Hitachi CONFIDENTIAL
EBIT interest coverage
EBITDA interest coverage
Funds from operations/total debt
Free operating cashflow/total debt
Pretax return on capital
Operating income/sales
Long-term debt/capital
Total debt/capitalization
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 22
How XBRL Can Help?
XBRL related input to RAROC performance measures is an important component of
ERM solutions
RAROC = Risk Adjusted Return on Capital = Net Income /
Economic Capital
Management
Accounting System
FTP
Income, interest
and fee
Non-interest
cost allocation
Total
income
A business’s
RAROC
Obligor’s rating
Facility rating
Operational cost -
Income
-
Fund cost
Expected Loss (EL)
=
Hurdle rate
Economic Capital (EC)
PD
UL
LGD
EAD
Hitachi CONFIDENTIAL
-
• Pricing
• Loan approval
EL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 23
How XBRL Can Help?
The RAROC Framework is based on comprehensive measures of risk
The RAROC Framework considers management objectives and constraints
Transactions
(within the authorized limit)
Fixed and variable
costs
Authorized
(limits)
OBJECTIVES and
CONSTRAINTS
Objectives:
• Revenues
• ROE
Constraints:
• Type of transaction
• Authorized risk exposure
(e.g. OpVaR limit)
Hitachi CONFIDENTIAL
Market risk
Credit risk
Operational risk
}
© 2005 Hitachi America, Ltd. All rights reserved.
Risk Adjusted
Profit
=
RAROC
Economic capital
Dr Robert Mark 24
How XBRL Can Help?
XBRL bases solutions can help at multiple levels of the RAROC Performance
Measurement Framework
RISK ADJUSTED RETURN
Risk
Adjusted
Return
RAROC
=
Risk
Adjusted
Capital
+ Interest Income
+ Non-Interest Income
+/-Indirect Revenue Sharing
- Interest Expense
- Non-Interest Expense
- Overhead Cost Allocations
- Funding Charge (loan originators)
- Expected Losses (EL)
+ RORC
ER
C
T
RISK ADJUSTED CAPITAL
+ Capital Required to Support Unexpected
Risk Losses from credit, market and
operational risks
- Capital Released by Correlation Effect
Hitachi CONFIDENTIAL
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Dr Robert Mark 25
How XBRL Can Help?
The economic capital level in the denominator of the RAROC equation is a function
of the Confidence Level.
Determining the appropriate Confidence Level (Coverage Level) will depend
on both the nature of the institutions businesses and its risk tolerance
S&P
Rating
AAA
AA
A
BBB
BB
B
CCC
CC
C
Default Probability Coverage
(Subsequent Year)
Level
0.01%
0.03%
0.11%
0.30%
0.81%
2.21%
6.00%
11.68%
16.29%
99.99%
99.97%
99.89%
99.70%
99.19%
97.79%
94.00%
88.32%
83.71%
Capital required to achieve
target coverage
Capital Standard
Coverage Level
A
99.90%
AA
99.97%
AAA
99.99%
Loss Rate
• The Capital Allocation methodology achieves comparability of returns by assigning capital
based on a common reference point across businesses
• Economic capital is defined as the amount of capital needed to reach a given survival
probability over a given timeframe
Hitachi CONFIDENTIAL
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Dr Robert Mark 26
How XBRL Can Help?
Superior ERM institutions regularly review and invest in those business that have superior
RAROC metrics and divest in those businesses that have inferior RAROC metrics.
115
COMPARE SOLUTIONS
Reward – average profit ($)
110
A is Lower risk , higher
profit than B
105
Clear Preference!
100
A
95
90
B
85
80
75
70
65
0
-100
-200
-300
-400
-500
-600
-700
-800
-900
-1,000
Risk – 1 in 100 year downside result ($)
Hitachi CONFIDENTIAL
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Dr Robert Mark 27
How XBRL Can Help?
For example: Superior ERM institutions regularly invest on those business
along the efficient frontier in the upper left quadrant
115
CAPITAL
RISK
APPETITE
Reward – average profit ($)
110
105
100
95
90
PROFIT TARGET
85
80
75
70
65
0
-100
-200
-300
-400
-500
-600
-700
-800
-900
-1,000
Risk – 1 in 100 year downside result ($)
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 28
How XBRL Can Help?
For example XBRL solutions are part of the solution space that enable sophisticated financial
institutions to evolve from a traditional buy & hold investor to active credit portfolio risk
management. Superior ERM institutions regularly invest on those business along the efficient frontier
in the upper left quadrant
Portfolio
Management
Client
Management
Origination &
Structuring
Credit
Rating
Risk/Reward
Risk
Updates Optimization
Management
Independent Risk
Assessment &
Rating
Portfolio
Additions
Portfolio
Based
Transfer
Pricing
Daily M-t-M
Expected &
Unexpected
Loss
Sell
Hedge
Securitization
Hold to
Maturity
New
Acquisition
Asset Purchase
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 29
Dr. Robert Mark
Dr. Robert M. Mark is the Chief Executive Officer of Black Diamond which provides corporate
governance, risk management consulting and transaction services. He serves on several Boards
such as the Fields Institute for Research in Mathematical Sciences, IBM’s Deep Computing Institute,
Checkpoint Canada, The Royal Conservatory and Entergy Koch’s Audit Committee of the Board. He
also serves on Checkpoint’s Investment Committee. In 1998, he was awarded the Financial Risk
Manager of the Year by the Global Association of Risk Professionals (GARP). He is the Chairperson
of The Professional Risk Managers’ International Association’s (PRMIA) Blue Ribbon Panel
Prior to his current position, he was the Senior Executive Vice-President and Chief Risk Officer
(CRO) at the Canadian Imperial Bank of Commerce (CIBC). Dr. Mark was a member of the
Management Committee. Dr. Mark’s global responsibility covered all credit, market and operating
risks for all of CIBC as well as for its subsidiaries. Prior to his CRO position, he was the Corporate
Treasurer at CIBC.
Prior to CIBC, he was the partner in charge of the Financial Risk Management Consulting practice at
Coopers & Lybrand (C&L). The Risk Management Practice and C&L advised clients on risk
management issues and were directed toward financial institutions and multi-national corporations.
This specialty area also coordinated the delivery of the firm’s accounting, tax, control, and litigation
services to provide clients with integrated and comprehensive risk management solutions and
opportunities.
Prior to his position at C&L, he was a managing director in the Asia, Europe, and Capital Markets
Group (AECM) at Chemical Bank. His responsibilities within AECM encompassed risk management,
asset/liability management, research (quantitative analysis), strategic planning and analytical systems.
He served on the Senior Credit Committee of the Bank. Before he joined Chemical Bank, he was a
senior officer at Marine Midland Bank/Hong Kong Shanghai Bank (HKSB) where he headed the
technical analysis trading group within the Capital Markets Sector.
He earned his Ph.D., with a dissertation in options pricing, from New York University’s Graduate
School of Engineering and Science, graduating first in his class. Subsequently, he received an
Advanced Professional Certificate (APC) in accounting from NYU’s Stern Graduate School of
Business, and is a graduate of the Harvard Business School Advanced Management Program. He is
an Adjunct Professor and co-author of “Risk Management” (McGraw-Hill), published in October 2000.
He also served on the board of ISDA as well as the Chairperson of the National Asset/Liability
Management Association (NALMA).
Hitachi CONFIDENTIAL
© 2005 Hitachi America, Ltd. All rights reserved.
Dr Robert Mark 30