Transcript Global Payments Opportunity - Mountain Mentors Associates

Advanced Risk Issues
“Seeing Around Corners”
Summary and Conclusions
Why were We Here?
Miami
April, 2007
Citi CIB
Advanced Risk Issues
Revenue Growth and
Risk Management in a
Complex Global Bank
The Economist – Survey of International
Banking – May, 2006
 Banks the world over are scrambling to become
larger…
 But at some point diseconomies of scale will also
start creeping in, with management finding it harder
to summarize everything that is going on in the bank
 This includes the neglect of concealed risks and the
failure of internal controls
 This problem afflicted Citigroup in 2002 – 2005 when
it was rocked by a string of compliance problems
 Risk management is the rock on which any
contemporary bank rests….
Moody’s 2005 Securities Industry Outlook
 “For all global trading and market-making firms, highly-
skilled risk management - broadly defined - is an
absolute necessity for the business model.
 “A robust corporate culture remains critical for
balancing short-term competitive pressures and the
long-term interests of a franchise.
 In a hotly competitive arena, fraught with litigation and
regulatory risk, an investment bank needs a collective
sense of right and wrong.
Advanced Risk Issues
The Market’s View of Risk Management
 “The financial innovations that have made risk
transfer and hedging possible have increased the
complexity of risk management, both financial and
operational.”
 “If a bank can establish risk management as a core
competency, I think that’s something the market
would value.”
 “No model,, and no software package, no matter how
sophisticated, can ever replace the skills of a
trained, experienced and conscientious risk
manager”
Advanced Risk Issues
The Market’s View of Risk Management
 “NAB’s internal control systems failed at every level to
detect the irregular currency options trading. As long
as the business unit turned a profit, other
shortcomings could be overlooked.”
 “Barings – There may be a temptation to view this
debacle as being caused by just one individual – the
“rogue trader” – but in reality the fiasco should be
attributed to the underlying structure of the firm, and
particularly to the lack of internal checks and
balances.”
 Private leveraged funds have become an important source of
protection to regulated institutions by being large sellers of
credit insurance in the rapidly growing market for credit default
swaps
 These changes in market participants have occurred in
conjunction with a dramatic acceleration in number and type of
derivative instruments.
 These developments have likely had the important impact of
allowing for a more efficient distribution and more effective
management of risk.
 All of these changes should move the market in the direction of
fostering the efficient allocation of credit and capital formation,
and thus enhancing the economy’s real growth potential.
 Stress testing and scenario analysis have become central to
the process of risk management
 Credit derivatives and structured credit markets enhance the capability
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to manage both pricing and liquidity risks.
Price discovery in the credit derivatives market reduces the risk of
mispricing loans.
Moreover, securitisation, which is another credit risk transfer instrument,
offers the possibility of managing more effectively the liquidity risk of
traditionally illiquid loans in the balance sheet.
Banks are moving from the traditional “buy-and-hold” model to the
“originate-and-distribute” model, whereby they distribute portfolios of
credit risks and assets to other market players.
Credit derivatives and structured credit markets are transforming the
financial system, whereby efficient risk allocation is becoming just as
important as capital allocation.
It is a valid question to wonder if we are converging towards a new
“integrated” financial system, whereby the traditional categories of bankbased or market-based financial systems may have to be revisited.
Federal Reserve Written Agreement
July, 2003
 “NOW, THEREFORE, Citigroup and the Reserve
Bank hereby agree as follows:…….within 60 days of
this Agreement, Citigroup shall submit to the
Reserve Bank an acceptable written legal and
reputational risk management program applicable to
Citigroup and its subsidiaries.
Fed Ties the Hands of Citigroup
No Major Acquisitions Allowed Until Its
Problems Are Fixed
THE WALL STREET JOURNAL
Page “C1”
March 18, 2005
The Federal Reserve barred Citigroup Inc. from major
acquisitions until the company fixes regulatory
problems that have gotten the financial-services
giant in trouble around the world, raising the stakes
for Chief Executive Charles Prince in his drive to
overhaul the bank's ethics.
"CLAWS AND FANGS"
Business Week
October 4, 2004
"The constraint on Citi's growth is not its market size,
nor its capital," says Bernstein's Mason. "It may well
be that Citi can't achieve its growth ambitions
because it cannot safeguard itself properly from
regulatory and reputation risk."
Moody's Investors Service upgrades the ratings of Citibank N.A. to
Aaa for long-term deposits and to A for financial strength
September 26, 2006
 The firm has made progress on strengthening culture and
improving controls, and has not suffered a major control
problem since having to close its Japanese private bank.
 However , management must continue to solidify cultural
change, notwithstanding shareholder pressure for earnings
growth
 Moody's assessed the effectiveness of risk controls,
measurement and information infrastructure as well as the
firm's risk governance and culture.
“Credit Matters Today”
March 5, 2007
 Strong earnings generation from an extraordinarily
diverse set of businesses allows Citigroup Inc. (Citi;
AA/Stable/A-1+) to cover some of the high risks that
it incurs.
 Citi has also achieved a substantial change in its
control environment in the aftermath of a wave of
heavy litigation expenses and criticism of its
business practices from regulators around the
world.
Citigroup Risk Management Priorities
Dave Bushnell - 2005
 The need to balance effectively between risk and
reward
 The real key to superior performance is to effectively
manage risk, not try to eliminate it
 “No” is an unacceptable answer when evaluating the
commitment of resources to a new project (deal).
“No, because…” and “Yes, if…” are much better
answers
 Changes in management’s appetite for and approach
to the management of risk in recent years have been
focused on operational risk, not market or credit risk
 As long as management is making the right specific
(local) risk related decisions, global risk is a
manageable task
Citigroup Risk Management Priorities
Bebe Duke – January, 2007
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Suitability is the key risk issue
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Market products are critical for revenue
growth
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- commodities
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- credit derivatives
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- "bespoke" interest rate derivatives and
"exotics"
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Need to raise awareness that the only way to
make money is to how to get to the yes.
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Client First Initiative
Citigroup Risk Management Priorities
Bebe Duke – 19 April, 2007
Dave Bushnell’s Priorities
 To manage risk well we must be fast and responsive
 We must encourage more intelligent risk taking
 A significant role of the CMB, bankers and risk
managers together, is to “get to yes”
 People and training
 Cost and efficiency of the risk process
Advanced Risk Issues
Tuesday, 17 April – Participants’ Risk Issues
 Getting the balance right
between efficient risk analysis
and local competitive pressure
 Commodity volatility
 Systems constraints –
operational capabilities vis a vis
new products
 Pricing Pressure from local
banks
 Systems to monitor and
manage complex structured
derivatives and deals
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Current market – excess liquidity
and competition
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Franchise risk related to complex
structured transactions
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Financing conditions – “covenant
lite” deals
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RAU migration and loss of control
of local analytic resources
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Political / geopolitical risk
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Proper model for middle market
growth
 Regulatory risk – deals leading
to franchise risk in local
markets
 Integration of recent
acquisitions – systems and
operations
 Dealing with the pendulum of
business / risk / business
 Higher risk associated with new
businesses
Advanced Risk Issues
Course Overview
Basic Credit Risk Analysis
– Industry Structure and Company Risk Analysis
– Balancing Business Risk and Financial Risk (Key
Success Factor Exercise)
– Identifying Winners and Losers.
– Early Warning Signs / Problem Recognition
– Avon Pharmaceutical Case
Advanced Risk Issues
Course Overview
Assessing management ability, business strategy, and
controls
– Management Competence and Business Strategy
(Corning Case)
– Business Controls (Citibank Dublin Case)
Advanced Risk Issues
Course Overview
Deal Structure and Risk
- Poland A2 Motorway Case
Converging Risk Issues – Credit Risk, Market Risk, Country
Risk, Derivatives Risk
How Does Citi “do risk”?
– Underwriting risk and conflict management
– Market risk / Convergence Risk
– Global portfolio management
– Operational risk
– Country risk
Advanced Risk Issues
Presentations to Illustrate How Citi Risk
Management is a Driver of Revenue Growth
 CIB Risk Management – Bebe Duke
 Global Portfolio Management – Bill Hartmann
 Market Risk / Convergence Risk – Murray Barnes
 Operational Risk – Eva Leighton
 Country Risk - Doug Smee
 Risk Management in EM – Andy Roy
 Problem Recognition / Early Warning Signs - Austin Erwin,
Jose Luis Michel
 Derivatives Risk – Patrick Pancoast
 Conflict Management / Franchise Risk – Bob Martin
Advanced Risk Issues
Quotes of the Week
 It’s not marked to market, it’s marked to guess!
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– Patrick Pancoast
I have a crystal ball, but I don’t really know how it works
– Bill Hartmann
Don’t mix high business risk with high financial risk
– Arnie Ziegel
The losses we’ll take on the credit are a multiple of the fees we earned
on the IPO
– Austin Erwin
Risk Management isn’t about controlling the business, it’s about
DOING business
– Patrick Pancoast
If you every hear the word “miracle”, it’s time to sell
– Doug Smee
The reasons covenants are disappearing is that what investors are
willing to accept
– Bill Hartmann
Advanced Risk Issues
Quotes of the Week
 Revenue up, cost down, complexity up, and risk up
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– Andy Roy
Breaking down the silos is a critical step to getting the company to
where we want to be
– Bebe Duke
If there is a party, keep the dogs away, but if there’s a problem, please
bring in the dogs
– Jose Luis Michel
If the numbers you see scare you, then it’s the numbers that you don’t
see that should terrify you.
– Doug Smee
There is tremendously more appetite for market risk taking and credit
risk taking, zero appetite for franchise risk taking, and very low tolerance
for loss
– Murray Barnes
In almost every one of our deals we have two sets of clients
– Bob Martin
Why do sophisticated investors like commercial loans as an asset
class?
– Bill Hartmann
Advanced Risk Issues
Quotes of the Week
 Many or most major business problems or losses are the result of a
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flawed business strategy
– Arnie Ziegel
Is it credit risk or market risk? YES!
– Patrick Pancoast
You are our clients!
– Bebe Duke
We live in very different neighborhoods, but we manage the risks very,
very well
– Andy Roy
How much can we lose on a bad day? What’s the worse that can happen?
– Murray Barnes
Unlike credit risk or market risk, we don't yet know how to dimension our
portfolio
– Eva Leighton
Every time we raise the idea, we get twenty reasons why we can’t sell
loans
– Bill Hartmann
Advanced Risk Issues
Quotes of the Week
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Companies go bankrupt because they 1) run out of cash, 2) fear that they’ll run
out of cash, or 3) their suppliers of liquidity fear that they’ll run out of cash
– Arnie Ziegel
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History doesn’t necessarily repeat itself, but it does have a very good memory
– Murray Barnes
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There’s no such thing as bad risk, it it’s priced correctly
– Patrick Pancoast
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Whose fault is it? You gave me the money / let me do it / told me to do the
trade
– Arnie Ziegel
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Do we have a tolerance for a higher level of operational risk in order to pursue
a business opportunity?
– Eva Leighton, Murray Barnes
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We’re creating tomorrows’ problems today, we just don’t know where they are
– Bill Hartmann
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It’s almost like the credit default swap market is bypassing the bond market
and going directly to the loan market
– Murray Barnes
Advanced Risk Issues
Quotes of the Week
 Bankers and Clients often rationalize away the signs of weakness
– Austin Erwin
 We all collectively need to be concerned that we are responding to our
customers
– Bebe Duke
 Active portfolio management, which has been discussed for years, is
now a global, industry-wide, activity
– Bill Hartmann
 By identifying early we both protect the balance sheet and create
opportunities
– Austin Erwin
 A really good risk manager is a partner to the business who actually
helps to solve a client’s problem
– Bill Hartmann
 We do too much too late, after doing too little too early
– Doug Smee
Advanced Risk Issues
Quotes of the Week
 Anything that is unsustainable will end. The longer it takes to end, the
bigger the crash will be when it happens.
– Doug Smee
 The “known unknowns” and “unknown unknowns”
– Murray Barnes
 We could go in with the axes and the knives, or we could make the
decision that the company could be a viable client
– Austin Erwin
 In the long run, treating customers fairly has proved to be good business
– Bob Martin / Stephen Cutler
 Credit default swaps allow us to bring liquidity to a market that is not
liquid
– Bill Hartmann
 Do not try to rationalize away increasing danger signals – instead, try to
find out why.
– Doug Smee
Advanced Risk Issues
Themes from the week…..
 Credit Risk is becoming a Traded Product
 Effective Risk Management is a tool for business
growth
 Risk Management is becoming a driver for business
growth
 The banking industry model is changing from
“originate and hold” to “originate and distribute the
asset or the risk”
 All risks are converging, the boundaries are
evaporating - Operational Risk, Franchise Risk, Market
Risk, Country Risk and Credit Risk
 Suitability and Appropriateness are increasingly
becoming major risk factors
Advanced Risk Issues
Themes from the week…..
 Growing complexity of the business is accelerating
and inevitable
 Reputation risk and Franchise risk are inherent in
almost every business activity of Citigroup
 Every aspect of our business has potential of
creating a loss due to an execution problem in the
system
 Good planning and risk identification can minimize
the over-reaction to a risk event and the potential
impairment of the value of a particular franchise
Advanced Risk Issues
Themes from the week…..
 Don’t add Financial Risk where there is high Business
Risk - industry and business risk drives a company’s
capital structure
 Choose clients carefully
 Many business problems arise from inadequate,
inappropriate, or ill managed strategies
 Citigroup is held to a higher standard, and not expected
to “aid or abet” improper or inappropriate loans,
investments, trades, etc.
Advanced Risk Issues -Themes from the
week…..
 Active portfolio management mitigates risk
 Citi has multiple constituents when considering risk
– issuers, investors, regulators, rating agencies
 Skepticism is an inherent part of risk assessment
 Why do smart bankers sometimes do things that, in
retrospect, just don’t make sense?
Advanced Risk Issues
Bankers and Risk Management
 Bankers Manage Client Relationships in order to provide
insight, early warning, and preferred positioning
 Bankers are “client experts”
 Bankers are Advocates – For Issuers and Investors
 Bankers must be Client Advisors rather than Responders
 Bankers must be Skeptics (Seeing Around Corners)
 Bankers are Responsible to Multiple Constituencies:
– shareholders
– clients
– regulators
– Investors
Why Were We Here?
● Excellent risk management creates shareholder
value and can be a major driver of high quality
revenue growth
● Excellent risk management for revenue growth
requires:
● “Seeing around corners” - finding risk where
we didn’t know or think it existed, and the
convergence of types of risks
● Skepticism to balance risk with the need to
generate revenue growth
● Identifying potential flaws of business
strategies – internal and clients
● A framework for choosing clients very carefully
● Understanding the increasing complexity of
products
Why Were We Here?
Excellent risk management for revenue growth
requires:
● Understanding the reputation and franchise
implications of business decisions
● Understanding that we will never see all risks,
so we
– Structure away from risk
– Choose clients carefully
– Pursue active portfolio management
– Create and maintain a superb control culture
and business culture
– Create and maintain systems for monitoring
risk
Why Were We Here?
 To review how Citigroup is managing risk, including
active portfolio management and reputation /
franchise risk
 Growth demands MORE risk and MORE reward, and
it’s up to you to get the balance right
 We can grow and still “stick to the fundamentals”,
often using new means of distributing risk
 To remind you that excellent bankers don’t hesitate
to say “I’m sorry, but I just don’t understand….”
 To recognize that we’re held to a higher standard,
not just because Citi is big, but because Citi is the
leader……………
Advanced Risk Issues 2007
Seeing Around Corners
Revenue Growth and
Risk Management
in a
Complex Global Bank
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