How regulation is changing the financial industry

Transcription

1 How regulation is changing the financial industry Sven Ludwig Senior Vice President, Risk & Analytics EMEA

2 LCR-xVA-FxA-xM Puzzle Enough 3 letter combinations but also for regulation? LCR := Liquidity Coverage Ratio xva : = CVA, DVA, FVA, AVA Credit Valuation Adjustment Debt Valuation Adjustment Funding Valuation Adjustment Additional Valuation Adjustment FxA : = FBA, FCA Funding Benefit Adjustment Funding Cost Adjustment xm := IM, VA Initial Margin Variation Margin

3 AGENDA Driver of regulation THE NEW TOP DOWN APPROACH MARKET INFRASTRUCTURE, COLLATERAL & LIQUIDITY THE NEW VALUE OF COLLATERAL MANAGEMENT (OPTIMISATION) THE BIG RISK TYPE TRANSFER TIKI-TAKA RISKMANAGEMENT POLITICS & RISK THE UNEXPECTED CONCLUSION

4 Regulation as source of risk The international stage of politics Regulation is the TOP risk No doubt, regulation arrived on the international stage - but of politics? Given the number of regulations: Is it orchestrated classical music or hopefully like jazz and not theater

5 Regulation is now made top down The process of new regulations (post crisis) G20 G20 Summits decide on requirements for change (e.g Pittsburgh, 2010 Seoul, ) FSB The Financial Stability Board (FSB) provides recommendations EBA, EIOPA,BCBS Regulation is everywhere Less dialogue with industry Implementation into national law

6 Changing perspectives An outsider view Regulation of the network, not (only) supernodes Provides nice ilustration of OTC exposure

7 AGENDA Liquidity & Collateral FORCED CHANGE IN MARKET PRACTICES THE NEW VALUE OF COLLATERAL MANAGEMENT (OPTIMISATION) THE BIG RISK TYPE TRANSFER TIKI-TAKA RISKMANAGEMENT POLITICS & RISK THE UNEXPECTED CONCLUSION

8 A starting point for explanation The known future becomes now Historically: Uncollateralized Default today: Collateralized Trade date Settlement date Trade date Settlement date Margin period Margin period Trade date 1 st margining date Cash flow based on trade Collateral flow Collateral position

9 Impact of market movement on liquidity There is no future, it s all now Default today: Collateralized Trade date Settlement date Margin period Margin period Next margin period date Margin period Cash flow based on trade Collateral flow Collateral position

10 Impact of market movement on collateral Getting closer to an Interest Rate Swap, it becomes bigger Attention: Sign changed! Multiple periods Focus on development of market Margin period Cash flow based on trade Collateral flow Collateral position

11 Initial Conclusion Future exposure matters, it need to be determined Market movements have significant impact on collateral Collateral movements have an impact on liquidity. Attention is required

12 Simulating the Future EE, PFE (simple IRS Portfolio) Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

13 EE, PFE, CVA (simple IRS Portfolio, no CSA agreement) Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

14 EE, PFE a simple IRS Portfolio with CSA agreement Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

15 Central clearing the silver bullet? There are nock on effects Central clearing (OTC) based on collateral. Collateral to meet Initial Margin (IM) and Variation Margin (VM) needs attention. Collateral is a currency

16 cash Repo Sourcing of Collateral Assets Collateral has become a complex currency... Collateral upgrade Repo Insurance Company A holding government bonds government bond equity trading inventory Bank A government bond cash Bank B Initial Margin Initial Margin government bond G7 sovereigns Clearing Broker government bond Insurance Company B Clearing House Interest Rate Swap Market Source: ZKB presentation at Swiss Finance Institute, Felix Oegerli, 15 November 2012

17 AGENDA OPTIMISATION CREATING VALUE WITH COLLATERAL THE BIG RISK TYPE TRANSFER TIKI-TAKA RISKMANAGEMENT POLITICS & RISK THE UNEXPECTED CONCLUSION

18 Unlock Potential of Collateral Centralized Profit Center Various collateral management requirements... Regulatory collateral requirements Repo / liquidity arrangements Derivatives collateral Lending program Efficient asset allocations Collateral Management Cross-product collateralization Optimized collateral allocation Collateral transfer pricing Client clearing Central Collateral Management & Trading Unit Sec Finance / Collateral Trading Repo/ reverse repo Securities lending Collateral trading Enterprise collateral inventory Cross-asset, real-time Key steering function tightly coupled with trading, treasury, risk Optimize the use of collateral assets Maintain liquidity for the bank Handle the collateralization processes across various products with high operational efficiency Increase trading revenues related to collateral utilization Fund trading activities and cover shorts Transfer price the cost of collateral Manage risk

19 Collateral Optimization: The Problem minimize

20 APPROACHES TO OPTIMISATION Customisable based on: Opportunity cost Funding cost eg repo rate, spreads RWA charges Movement costs additive and multiplicative penalties to reflect settlement risk (subs) CSA returns Customisable constraints Incorporate linear and non-linear constraints Optimised performance accuracy vs solving time Provable optimal solution supports waterfall and shows relative benefits Please visit:

21 Observation 1/2 Collateral matters significantly Funding costs: Collateral does not come for free Adequate pricing and simulation is a complex task (CVA, FVA, IM/VA Collateral demand prediction) Approach to collateral will change

22 AGENDA TRANSFER OF RISK THE INTEGRATED RISK LOOP TIKI-TAKA RISKMANAGEMENT POLITICS & RISK THE UNEXPECTED CONCLUSION

23 Regulations change of collateral & liquidity Regulations are linked EMIR: Central clearing of OTC derivatives Banks will need more collateral Basel Paper(s): Margin requirements for noncentrally cleared derivatives No escape, banks will need more collateral Basel III: Liquidity ratios LCR and NSFR (+ ILAAP) Banks will need high quality collateral for liquidity buffer Banks will need more structural term funding BUT: You cannot get risk of risk, but transfer 24

24 The big transfer across types of risk Challenge: The management of the interwoven loop? The old sequential world (before crisis) The new (intervowen) risk loop world (after crisis and regulation) Credit Risk Credit Risk Market Risk Market Risk Oprisk RWA CAPITAL LIQUIDITY COLLATERAL Counterparty Risk Counterparty Risk Liquidity Risk/Market Risk

25 AGENDA TIKI-TAKA RISKMANAGEMENT BCBS239 POLITICS & RISK THE UNEXPECTED CONCLUSION

26 The demand for Tiki-Taka risk management? Nice, but wishful thinking? Can tiki-taka tactics keep risk management on the ball? sroom/viewpress/irn=8540#.vgnd25gwfiv 27

27 Tiki-Taka Risk Management Nice, but impossible to achieve How do we achieve the integrated risk management? Does the regulator help?

28 Principles for effective risk data aggregation & reporting The regulator put integrated risk management on the spot Why is the regulator looking at it? Banks IT and data architectures were inadequate to support the broad management of financial risks. What is BCBS239 about? principles on: Sound practices for risk management Principles for : IT architecture, Data Quality, Risk Reporting 29 Financial Institutions should generate accurately and reliable risk data. The risks captured should be complete and up-to date. Risk reports should be validated, comprehensive, clear, useful and delivered in adequate frequency (includes ad-hoc) to the relevant (internal) parties

29 What is it really about Step towards impact It seems so simple The Principles do not add new concepts increase regulatory capital increase regulatory reporting... focus on the details change the structure of the financial market request something implausible So why do we bother? 30

30 Keep calm? The integrated loop a requirement from collateral/liquidity KEEP CALM AND LOVE TIKI-TAKA 31 31

31 Example: Germany Bank s Status Quo vs. BCBS#239 Frequency Enterprise risk report: Today often quarterly Monthly Time lag between data and delivery of risk report: Today T+7 to T+56 T+10 Risk report via push a button Risk Manager calculates and comments (differences in stored results and comments) risk values are provided, comments in DWH Automated interim layer Excel/Access for Aggregation & Processing Risk Data are provided and not calculated by risk manager Focus of Risk Manager Today s job about data collection and QS Majority of time spend: 32 Analysis (Source: DEUTSCHE BUNDESBANK)

32 The aggregation challenges and approaches Strategic infrastructures: Its about a concerted approach High quality data IT Architecture Risk Reports Ingrediends for meal (spaghetti Pomodoro= + Kitchen with + cooking tools Cooking book Michelin stared meal Profitable steering of the financial insitution 33

33 What is it about Step towards impact How wisdom can be gleaned from information The Principles do: request the obvious require data quality require data accuracy and integrity require timliness require adaptability (ad-hoc, crisis, internal & reg. changes)... require a reconciled risk production process address the key pain points nobody wanted to address earlier address the needs of the executive board The Impact: do change risk management in its foundation it is a game changer for banks (& other financial institutions)... it is a game changer for a financial institutions IT 34

34 Some facts on BCBS 239 Rolling down from Tier 1 & spill over from the group Timeline: G-SIFIs (G-SIBs & SII): The principals have to be implemented completely by 1 st of Jan 2016 D-SIB: 3 years after their designation as D-SIB Regulator already now expects actions and efforts to fulfill the principals Impact if regulation is not fulfilled Regulator can set risk limits or limit growth For G-SFIS only? No, D-SIB as well and group wide All financial institutions dependent on discretion / judgment of national regulator 35

35 The challenges and approaches It is a program, not project Common building blocks the approaches 1) Data quality framework 2) Risk reporting (practices & capabilities) 3) IT architecture 36

36 BCBS239 the ultimate regulation? It is a $1.5bn p.a. investment of the industry $ BCBS#239 linked investments $ $ SII and other D-SIBs G-SIBs $ $ $ Source: SunGard 37

37 The BCBS239 Message CEOs understood the broader context CEOs expect that the principles extend to other areas It is about steering the institution more accurate It is about the integration of Risk, Finance, regulatory reporting and provide business access to the combined world. The interwoven risk management, not just via market infrastructure regulation. 38

38 AGENDA THE HIDDEN TOOLS Politics and regulation THE UNEXPECTED CONCLUSION

39 What s about capital? The entire pillar one is worked. Focus on the fairly final one: BCBS279: The standardized approach for measuring counterparty credit risk exposures ( SA- CCR )

40 What does SA-CCR aim at? Address the known deficiencies of the CEM and the SM Improves the risk sensitivity of the capital framework without creating undue complexity Suitable for wide variety of transactions (unmargined, margined, bilateral cleared, centrally cleared) More reflective of legal and economic offsetting Implementable simply and easily Regulatory bodies: Less room for discretion 41

41 The impact of SA-CCR vs. CEM The reality: A push towards central clearing TRANSACTION(S) CEM (% OF NOTIONAL) SA-CCR (% OF NOTIONAL) DETAILS OF SA-CCR CALCULATION SA-CCR / CEM 01 5-year Interest Rate Swap Unmargined 0.5% 3.1% 0.5% Add-On x 1 Maturity Factor x 4.4 Supervisory Duration x 1.4 Alpha 620% 02 5-year IRS Margined 0.5% 0.93% 0.5% Add-On x 0.3 MF x 4.4 SD x 1.4 Alpha 186% 03 3-month FX Forward Unmargined 1% 2.8% 4% Add-on x 0.5 MF x 1.4 Alpha 280% 04 6-month Equity Option (50% Delta, MtM 2%) 8% (2%MtM + 6% Add-on) 18.66% (2% MtM + 32% Add-on x 0.71 MF x 0.5 Delta) x 1.4 Alpha 233% 05 1-year Equity Forward 6% 44.8% 32% Add-on x 1 MF x 1.4 Alpha 747% 06 Two completely offsetting 5Y IR Swaps 0.2% (0.5% x 40% due to zero NGR) 0% Transactions are long/short in same hedging set hence completely net Add-ons 0% 07 Two opposite 6M FX Options (Buy & Sell the same Option) 0.4% (1% x 40% due to zero NGR) 0% Transactions are long/short in same hedging set hence completely net Add-ons 0% 08 Two 6M FX Forwards (USD/EUR + GBP/USD) with opposite MtMs 0.4% (1% x 40% due to zero NGR) 3.96% 4% Add-on x 0.71 MF x 1.4 Alpha Transactions are in different hedging sets (based on currency pairs) and hence add-ons don t offset 990% 42

42 Pre-Final conclusion Does is work together? EMIR Principles for effective Risk Data aggregation and reporting Basel III (Liquidity Ratios) Rework of Pillar I: SA-CCR Regulation is an orchestrated approach Where are the politics? 43

43 How politics enter the game Stress Test Result The tools of local accounting

44 AGENDA THE CONCLUSION Unexpected?

45 Basel III capital buffer(s): Focus on core tier-1 capital The (non-) level playing field in Europe Systemic Risk Buffer Max 5,0 Max 5,0 Max 7,5 Max 8,5 13,5% Capital Conservation Buffer Max 2,5 Max 2,5 Countercyclical Buffer 1,875 2,5 Total Capital 8,0 8,0 8,0 8,0 8,0 5,5 6,0 6,0 6,0 Core Capital Core Tier I capital 4,0 2 4,0 4,5 4,5 4,5 8% Source: Prof. Hermann Schulte Mattler

46 Final conclusion Steering Core-Tier-1 Capital is the focus After adoption of the changes, risk bearing capacity becomes a secondary constraint Not regulation is the top risk, its politics The country focus vs. Europe 47

47 THANK YOU Dr. Sven Ludwig Senior Vice President, Risk & Analytics EMEA Please visit: