Risk Management A Perspective on the Financial Crisis

Transcription

1 Risk Management A Perspective on the Financial Crisis Ruairi O Healai June 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public

2 Agenda Our Commitment to Risk Management Financial Crisis from a Risk Management Perspective How have we Developed our Risk Management Framework and is this a Long-term Solution? For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 2

3 Risk Management in the UniCredit Group Matrix Approach The Group Risk Management framework ensures balance between RISK TYPE and TRANSACTION SPECIALIZATION Divisional Transactions CIB & PB CEE RETAIL TREASURY Asset Management CREDIT & CROSS BORDER RISKS Risk Portfolios MARKET RISKS Liquidity Interest Rates Forex Trading OPERATIONAL & REPUTATIONAL RISKS Group Risk Appetite translated by Group Risk Portfolio Managers into risk strategies, limits and policies across all Group Business Areas and Legal Entities Transactional Risk Managers develop Divisional and local strategies granting consistency with portfolio risk guidelines Strategic Risk Management Restructuring For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 3

4 Risk Management in Pioneer Investments Matrix Approach The Pioneer Investments Risk Management framework ensures balance between RISK TYPE and REGIONAL STRUCTURE Regional Setup US REGION CEE REGION EUROPEAN REGION Risk Portfolios PERFORMANCE INVESTMENT RISK OPERATIONAL RISK PORTFOLIO CONSTRUCTION Performance team identifies drivers of performance. E.g.: stock picking, allocation to a class or sector, style or size bias etc. and reports to senior management, Board of Directors and investments teams Investment Risk team measures risk at an aggregated level. Designed to control the level of risk relative to a benchmark or Value at Risk Operational Risk partners the different businesses and locations to identify, mitigate and monitor risks that arise in every process, system and human intervention Portfolio Construction team works with the fund managers to ensure that there is an appropriate balance between risk taken and the desired objective of the investment in each investment strategy Strategic Risk Management * This function is called PGAM Governance and Oversight For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 4

5 Pioneer Investments Operational Risk Framework - Key Services Activities, Tasks, Coordination and Control Risk Assessment & Risk Mapping Insurance Management Key Risk Indicators abc Local Business Support Scenario Analysis Top Management Reporting Internal Loss Data Collection Global Op. Risk Policy External Losses Benchmarking For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 5

6 Pioneer Investments Performance Framework Activities, Tasks, Coordination and Control Performance Measurement: GIPS Key Performance Indicators Performance Measurement: Portfolio Level abc Style Analysis Peers Analysis Performance Attribution For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 6

7 Pioneer Investments Risk Control Framework Aggregate Product Limits: Defines the outer perimeter of the Mandate VaR and Tracking Error Combination of Prospectus limits and additional risk controls Product Parameters: Detailed Product limits to ensure traction of investment mandate through the cycle Risk Factor Analysis: Providing detailed risk factor attribution to ensure portfolio construction is generating risk sensitivities to the core investment strategy. Aggregate Product Limits Product Parameters Risk Factor Analysis For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 7

8 Pioneer Investments Risk Control Framework Activities, Tasks, Coordination and Control Risk Measurement Stress Testing Risk Monitoring abc Back Testing Risk Limits Risk Control For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 8

9 Pioneer Investments Risk Budgeting Framework Activities, Tasks, Coordination and Control Risk Budgeting Measure and Monitor Risk Consumption Scenario Simulation Performance Contribution by Strategy abc Risk Adjusted Performance Alpha Strategies and targets Risk Factor Analysis Optimisation For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 9

10 Agenda Our Commitment to Risk Management Financial Crisis from a Risk Management Perspective Summary of Context Our Experience How have we Developed our Risk Management Framework and is this a Long-term Solution? For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 10

11 Low Volatility Environment : The Calm Before the Storm Low Volatility Protracted period of low volatility Risk/Return Ratios were extremely low Emphasis on alpha created a huge demand for higher yielding products As more and more investors poured into new asset classes, spread tightened to historical levels, leaving little room for upside However, more importantly, it meant that volatility was at stabling low levels for many years For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 11

12 Low Equity Volatility Lehman Default Kuwait Invasion LTCM Crisis Tech Bubble Mini Credit Crisis Start of Crisis Bull markets are generally built on low volatility, small incremental changes, while market adjustments are generally met with violent surges into volatility. Source: Bloomberg, 27 March 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 12

13 Equity Volatility : Just Prior to the Meltdown Sustained period of Low Volatility Crisis Begins Sustained period of low volatility. Source: Bloomberg, 27 March 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 13

14 Interbank Rate was Similarly Trading at Sustained Low Rates Counterparty Risk was not priced in at all Source: ECB, 22 June 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 14

15 Europe Corporate CDS Index (Corporate Spreads over Swap Curve) Crisis Begins..same story for Corporate Spreads Source: Bloomberg, 27 March 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 15

16 Cross Over CDS Index (Euro-High Yield Spreads over Swap Curve) Crisis Begins..and again for High-Yield spreads.. Source: Bloomberg, 27 March 2009 For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 16

17 By 2004 Focus shifted towards how to improve returns in a low volatility and low interest-rate environment Emphasis switched to product innovation, use of derivatives and expansion of Hedge Fund investor base For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 17

18 Financial Product Innovation This occurred across all sectors of the Financial Services market Investment Banking Growth in Structured Products (CDO, CDO 2, Asset Backed Structured) Emphasis on wrapping risky assets, separating origination from loan management Asset Management UCITS Regulation allowed a large array of new instrument types New Fund Types: 130/30 Equity Strategies became the way to increase risk in a low volatility environment Commercial Banking 100% Mortgages for Residential Homebuyers (not all countries) Securitisation: SIV structured to allow off-balance sheet mechanisms of transferring risky assets Surge in Sub Prime Mortgages in the US Explosion in Derivatives Usage and Leverage More underwriting capacity than ever before in CDS market Rating Agencies employed to sell increasingly complex structures. the problem in 2004 was how to increase risk, not reduce it For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 18

19 Regulator Moves to More Sophisticated Risk Management Approaches UCITS III moves to encourage sophisticated risk management Rather than regulate hedge funds, regulators expanded UCITS vehicle scope Crude measures such as global exposure were replaced by more advanced techniques, notably Value at Risk (VaR) What is VaR and what are its limitations? For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 19

20 Value at Risk Estimates maximum loss that a portfolio might sustain over a period of time, with a given confidence level However there are a large number of inputs that need to be considered individually: 1. Method of Calculation. Historical, Parametric or Monte Carlo 2. Depth of timeseries: 1 year, 3 years or longer? 3. How are complex instruments mapped? 4. How effective is VaR in a stable volatility environment? Correlation is not stable in stressed market conditions For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 20

21 VaR Estimates or Inputs VaR relies on historical information, normality or subjective inputs. a. Assuming normality is a weak proposition b. Assuming historical data predicts future trends is challenged 5% c. Assuming subjective inputs are better than a and b relies on the individuals and market experience -10MM Possible Profit/Loss Risk models have been strongly criticised by market commentators such as Taleb However, the issue has been the overdependence and poor understanding of the control rather than the control itself For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 21

22 VaR was to be Introduced Alongside other Risk Controls Backtesting and stress testing were the additional elements to the sophisticated framework Backtesting: constantly testing the strength of the model in terms of risk forecasting Stress Testing: Assessing how a portfolio behaves in stressed environments. This should be integrated with the investment decision process Many of these controls were performed purely as a regulatory requirement For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 22

23 Search for Alpha, Overconfidence and More Sophisticated Risk Control Frameworks Each element contributed to creating an environment where risk taking increased dramatically Search for alpha encouraged leverage and more complex products to become integral to financial markets Historically low levels of volatility and interest rates deepened the demand for these product types An emphasis on risk control through volatility driven frameworks, without proper stress testing, led to significant weakening of the control environment For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 23

24 Agenda Our Commitment to Risk Management Financial Crisis from a Risk Management Perspective How have we Developed our Risk Management Framework and is this a Long-term Solution? What did we Learn (Internally and Externally)? For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 24

25 Unprecedented Risk Levels across all Risk Types Just about every risk type was triggered during the crisis Credit: Lehman Brothers Event Market: Dramatic market behaviour Liquidity: Market segments froze Reputational: Financial sector in crisis Strategic: Intervention of government as only lender in the market Insurance: Basis risk dramatically widens Systematic: Asset classes behave similarly, correlation dramatically increases, little diversification benefits for investors For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 25

26 How do we Respond? Industry Level Systematic Market Failure requires response at the government and industry level (such as providing listed markets for OTC and Derivative type instruments) Counterparty Risk is most definitely back on the table. More stringent controls on ISDAs and CSAs and stronger legal representation Liquidity Risk: Industry response needed to assure investors of access to their investments For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 26

27 How do we Respond? Regulating Growth Overall, the issue is how we behave in the good times, not what happens in the markets When revenue, growth and asset bubbles are in full flow, nobody wants to hear about the apocalypse The invisible hand approach will be replaced with stronger financial regulatory control To manage excesses, Risk Management and Regulators need to be anti-cyclical. To manage through the cycle, risk must be at all times under a proper control framework For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 27

28 What are the Lessons Learnt? Better mapping of instruments at data entry level Better product definition to ensure clients are aware of investment mandate Client expectations need to be aligned with the upside and downside of alpha Improve the independence and penetration of Risk Management Need for staff with market experience. Avoid silo approach to risk management Stress Testing to be further integrated with the investment process and mandate definition Regular monitoring of Liquidity/Redemption Risk For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 28

29 Recent Improvements to Pioneer Investments Risk Management Appointment of Asset Management Division Risk Officer to UCG Risk Executive Committee Direct reporting line to Chief Executive Officer, increasing independence Reinforcing Centres of Excellence to ensure consistency of service across all locations New Credit Risk Framework to enhance counterparty exposure management Rolling out New Investment Risk Framework to strengthen the control framework of investment mandates Increased Mandate Definition and Monitoring to ensure traction to investment objective For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 29

30 Important Information Unless otherwise stated all information contained in this document is from Pioneer Investments and is as at 19 June Past performance does not guarantee and is not indicative of future results. Unless otherwise stated, all views expressed are those of Pioneer Investments. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. More recent returns may be different than those shown. Please contact Pioneer Investments for more current performance results. This material is not a prospectus and does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services, by or to anyone in any jurisdiction in which such offer or solicitation would be unlawful or in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation. This information is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities or services in the United States or in any of its territories or possessions subject to its jurisdiction to or for the benefit of any United States person (being residents and citizens of the United States or partnerships or corporations organized under United States laws). The non-us Pioneer Investments range of products have not been registered in the United States under the Investment Company Act of 1940 and units of these funds are not registered in the United States under the Securities Act of This document is not intended for and no reliance can be placed on this document by retail clients, to whom the document should not be provided. This content of this document is approved by PGIL. In the UK, it is directed at professional clients and not at retail clients and it is approved for distribution by Pioneer Global Investments Limited (London Branch), 123 Buckingham Palace Road, London SW1W 9SL, authorised by the Financial Regulator in Ireland and regulated by the Financial Services Authority for the conduct of UK business. The Pioneer Investments funds are an unregulated collective investment scheme under the UK Financial Services and Markets Act 2000 and therefore do not carry the protection provided by the UK regulatory system. Pioneer Funds Distributor, Inc., 60 State Street, Boston, MA ( PFD ), a U.S.-registered broker-dealer, provides marketing services in connection with the distribution of Pioneer Investments products. PFD markets these products to financial intermediaries, both within and outside of the U.S. (in jurisdictions where permitted to do so) for sale to clients who are not United States persons. For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use 25 June For Broker/Dealer Use Only at the European Capabilities Forum June 2009 and Not to be Distributed to the Public June 2009 Page 30