Risk Measures Overview A Cross-Form Comparison Guide Version 2 Advise Technologies www.advisetechnologies.com support@advisetechnologies.com
Risk Measures Overview A Cross-Form Comparison Guide Published May 2017. Copyright 2017 Advise Technologies. All rights reserved. Advise believes the information in this publication is accurate as of its publication date. The information is subject to change without notice and does not represent a commitment on the part of Advise. Advise has exercised care to avoid errors but makes no warranty that this publication is error or omission free. If you find any problems in the publication, please report them to us in writing. THE SOFTWARE AND THE INFORMATION IN THIS PUBLICATION IS PROVIDED AS IS. ADVISE MAKES NO REPRESENTATIONS OR WARRANTIES WHATSOEVER, INCLUDING WITHOUT LIMITATION IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. The Software and this publication contain proprietary information of Advise; they are provided under a license agreement containing restrictions on use, copying and disclosure and are also protected by copyright, patent and other intellectual and property laws. Reverse engineering, disassembly or decompilation of the software is prohibited. Except as expressly permitted in the license agreement, no part of this publication may be reproduced or transmitted in any form or by any means. All trademarks mentioned in this document belong to their respective owners. 2017 Advise Technologies CONFIDENTIAL Page i
Table of Contents 2017 Advise Technologies CONFIDENTIAL Page ii
OVERVIEW Regulatory reporting forms seek to measure risk by specifying: The name of the metric used to calculate risk How risk is defined The formula used to calculate risk Required shock values that must be applied Advise compared six forms Solvency II, AIFMD, Form PF, CPO-PQR, Open Protocol, and Form N-PORT to evaluate how risk measures are applied across asset classes. Our analysis included the following risk measures and asset classes: Interest Rates, Spread, Property, Implied Volatility, FX Delta, Commodities, Default Risk, and Value at Risk (VaR). Our analysis found that: Risk measures are defined differently by each form across asset classes. The formula used to calculate risk is identical across the following asset classes (where applicable): Equities, Interest Rate, Spreads, Property, and Implied Volatility. Shock values are different across asset classes. For VaR: definitions, holding period, confidence level, data set period, and calculation methods vary by form. NOTE: In this document, Solvency II risk metrics are based on the standard formula as defined in Directive 2009/138/EC and Regulation 2015/35/EU. NOTE: A complete list of source materials appears in the References section. NOTE: For Form CPO-PQR, the risk measures described in this document are only applicable to large pools (Question C2 4). NOTE: For AIFMD, the risk measures described in this document are defined in an ESMA opinion and vary by jurisdiction; individual jurisdictions may change their requirements in the future. NOTE: For AIFMD, stress tests (Question F 279-280) were not included as part of this analysis. 2017 Advise Technologies CONFIDENTIAL Page 1
EQUITY Form Metric Definition Shock Type Shock Values Solvency II SCR Equity (Type 1/2) Sensitivity of the values of assets, liabilities, and financial instruments to changes in the level or in the volatility of market prices of equities (equity risk). Current value * X% - 22% or - 39% or - 49% AIFMD Net Equity Delta The portfolio s sensitivity to movements in equity prices. Current value * X% - 20% Form PF Change in Equity Prices The portfolio s sensitivity to movements in equity prices where shocks are applied to LONGS & SHORTS separately. CPO-PQR Change in Equity Prices The portfolio s sensitivity to movements in equity prices where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Current value * X% Current value * X% +/- 5% and +/- 20% +/- 5% and +/- 20% Open Protocol Change in Equity Prices The portfolio s sensitivity to movements in equity prices calculated for Large/Small Cap. The change is relative to the current equities level. Current value * X% +/- 10% Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 1
INTEREST RATES Form Metric Definition Shock Type Shock Values Solvency II SCR Interest Sensitivity of the values of assets, liabilities, and financial instruments to changes in the term structure of interest rates, or in the volatility of interest rates (interest rate risk). NOTE: Inflation risk is not explicitly modelled in SCR and it is assumed its effect is already included into the prescribed shock. Current rate + X% Up shock: MIN [1%, r+70% / r+20%] Down shock: MAX [0%, r-75% / r - 20%] AIFMD Net DV01 Basis Point Value the portfolio s sensitivity to a change in the yield curve. Assume an increase of 1bp in the yield curves that the fund is exposed to (assume a parallel shift). Report the effect on the total net asset value of the AIF as a monetary value in base currency for each maturity bucket as specified (short/intermediate/long). Current rate + X% 0.01% Form PF Parallel Shift of Yield Curve The portfolio s sensitivity to parallel shifts of yield curve (risk-free rates) where shocks are applied to LONGS & SHORTS separately. Current rate + X% +/- 0.25% and +/- 0.75% CPO-PQR Parallel Shift of Yield Curve The portfolio s sensitivity to parallel shifts of yield curve (risk-free rates) where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Current rate + X% +/- 0.25% and +/- 0.75% Open Protocol Change in Sovereign Rates (RFR) The portfolio s sensitivity calculated to change in Shortterm (<1Y) and Long-term (>1Y) interest rates separately. Change is relative to the current interest rate curve. Current rate + X% +/- 5% and +/- 10% 2017 Advise Technologies CONFIDENTIAL Page 2
Form Metric Definition Shock Type Shock Values Form N-PORT DV01 and DV100 The portfolio s sensitivity to changes in interest rates for each currency that is 1% of the fund s NAV. Must be calculated over the following maturities: 3-months, 1- year, 5-years, 10-years, and 30-years. (NOTE: If maturities fall between those durations, then linear interpolation must be applied.) Firms may use their own methodologies for this calculation. Current rate + X% +/- 0.01% and +/- 1% 2017 Advise Technologies CONFIDENTIAL Page 3
SPREAD Form Metric Definition Shock Type Shock Values Solvency II SCR Spread Sensitivity of the values of assets, liabilities, and financial instruments to changes in the level or in the volatility of credit spreads over the risk-free interest rate term structure (spread risk). Current spread * X% Complex calculations between 0.9% - 100% AIFMD Net CS01 The portfolio s sensitivity to a change in credit spreads. Assume a general increase in all credit spreads of 1bp. Report the effect on the total net asset value of the AIF as a monetary value in base currency for maturity bucket as specified (short/intermediate/long). Current spread + X% 0.01% Form PF Credit Spreads The portfolio s sensitivity to change in credit spreads where shocks are applied to LONGS & SHORTS separately. CPO-PQR Credit Spreads The portfolio s sensitivity to change in credit spreads where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Open Protocol Credit Spreads The portfolio s sensitivity calculated to change in credit spreads split between Investment Grade and Non- Investment Grade bonds reported separately. Change is relative to the current interest rate curve. Current spread * X% Current spread * X% Current spread * X% +/- 0.5% and +/- 2.5% +/- 0.5% and +/- 2.5% +/- 5% and +/- 10% Form N-PORT SDV01/CR01/CS01 The portfolio s sensitivity to change in credit spreads. Shift is applied to the option-adjusted spread aggregated by investment/non-investment grade. (NOTE: Credit spread may also relate to CDS spread.) Current spread * X% +/- 0.01% 2017 Advise Technologies CONFIDENTIAL Page 4
PROPERTY Form Metric Definition Shock Type Shock Values Solvency II SCR Property Sensitivity of the values of assets, liabilities, and financial instruments to changes in the level or in the volatility of market prices of real estate (property risk). Current value * X% - 25% AIFMD Form PF CPO-PQR Open Protocol Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 5
IMPLIED VOLATILITY Form Metric Definition Shock Type Shock Values Solvency II Volatility is not implicitly tested in SII SCR for asset managers. However, an insurance company can tweak volatility at high-level by recalculating its liabilities and making adjustments to volatility input. AIFMD Vega Exposure Current vega factor (multiplier) of the portfolio defined as the sensitivity of the total net asset value to an increase of 1 percentage point of implied volatilities. Current volatility * X% +/- 10% Form PF Implied Volatility The portfolio s sensitivity to change in implied volatilities for options where shocks are applied to LONGS & SHORTS separately. CPO-PQR Implied Volatility The portfolio s sensitivity to change in implied volatilities for options where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Current volatility * X% Current volatility * X% +/- 4% and +/- 10% +/- 4% and +/- 10% Open Protocol Implied Volatility The portfolio s sensitivity to change in implied volatilities for options. Change is relative to the current implied volatility level. Current volatility * X% +/- 10% Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 6
FX. Form Metric Definition Shock Type Shock Values Solvency II SCR FX Sensitivity of the values of assets, liabilities, and financial instruments to changes in the level or in the volatility of currency exchange rates (currency risk). AIFMD Net FX Delta Assume all currencies appreciate by 20% relative to the fund s base currency. Report the effect on the total net asset value of the AIF as a monetary value in base currency. Current FX rate * Shock +/- 25% Current FX rate * Shock + 20% Form PF Currency Rates The portfolio s sensitivity to change in currency rates relative to the fund's base currency where shocks are applied to LONGS & SHORTS separately. CPO-PQR Currency Rates The portfolio s sensitivity to change in currency rates relative to the fund's base currency where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Current FX rate * Shock Current FX rate * Shock +/- 5% and +/- 20% +/- 5% and +/- 20% Open Protocol Currency Rates The portfolio s sensitivity to change in exchange rate of USD relative to the portfolio local currencies. Current FX rate * Shock +/- 10% Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 7
COMMODITIES Form Metric Definition Shock Type Shock Values Solvency II SCR Equity 2 Sensitivity of the values of assets, liabilities, and financial instruments to changes in the level or in the volatility of market prices of equities (equity risk). Commodities are treated as Equity type 2. AIFMD Net CMD Delta Assume the prices of all physical commodities increase by 40%. Report the effect on the total net asset value of the AIF as a monetary value in base currency. Current value * X% - 49% Current value * X% + 40% Form PF Commodity Prices The portfolio s sensitivity to movements in commodity prices where shocks are applied to LONGS & SHORTS separately. CPO-PQR Commodity Prices The portfolio s sensitivity to movements in commodity prices where shocks are applied to LONGS & SHORTS separately (for LARGE pools only). Current value * X% Current value * X% +/- 10% and +/- 40% +/- 10% and +/- 40% Open Protocol Commodity Prices The portfolio s sensitivity to movements in commodity prices with additional breakdowns for shocks in Metal and Energy prices. Current value * X% +/- 10% Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 8
DEFAULT RISK Form Metric Definition Shock Type Shock Values Solvency II SCR Default Risk Consists of default risk to counterparty exposure types 1 and 2 with an interaction (covariance) coefficient of 1.5 and given by the formula in Art. 189 of the Regulation. Currently, this is not in the scope of the Consensus RMS Solvency II module and is calculated by an insurance company based on input from the asset manager. Complex formula based on loss-given default (LGD) and variance of loss AIFMD Form PF Default Rates The portfolio s sensitivity to change in default rates of the fund where shocks are applied separately to LONGS & SHORTS, ABS, and Corporate Bonds/CDS. CPO-PQR Default Rates The portfolio s sensitivity to change in default rates of the fund where shocks are applied separately to LONGS & SHORTS, ABS, and Corporate Bonds/CDS. Applies only to LARGE pools. Current value + X% Current value + X% +/- 1% and +/- 5% +/- 1% and +/- 5% Open Protocol Form N-PORT 2017 Advise Technologies CONFIDENTIAL Page 9
VAR VaR Definition Holding Period Confidence Level Data Set Period Calculation Solvency II AIFMD Form PF CPO-PQR In SII, SCRs are calibrated by insurance companies (high level) and not asset managers. There is no requirement for an asset manager to calculate VaR for SII. Reporting risk measures as outlined in ESMA opinion ESMA/2013/1340. Form PF Q40: During the reporting period, did you regularly calculate the VaR of the reporting fund? If YES, then fill in VaR values. QC2-4 (Large pools only): Did large CPO regularly calculate the VaR of Large Pool during reporting period? 20 Days 99% 250 Days Historical Simulation Parametric Monte-Carlo Simulation Variable Value Variable Value Variable Value Historical Simulation Parametric Monte-Carlo Simulation Other Variable Value Variable Value Variable Value Historical Simulation Parametric Monte-Carlo Simulation Other Open Protocol Section 8 (VaR/CVaR) 1 day 95% Variable Value Historical Simulation Parametric Monte-Carlo Simulation Other Form N-PORT Managers can determine the values used for these fields. All values must be disclosed on the form itself. 2017 Advise Technologies CONFIDENTIAL Page 10
GREEKS AND RELATED DATA POINTS The table below shows how different risk metrics apply across forms. Open Protocol Solvency II Form PF AIFMD CPO-PQR Form N-PORT Beta Delta Gamma Vega Theta CS01 * DV01 Z-Spread Yield to Maturity Yield to the Next Call OAS * May also apply to SDV01 and CR01. May also apply to DV100. 2017 Advise Technologies CONFIDENTIAL Page 11
Open Protocol Solvency II Form PF AIFMD CPO-PQR Form N-PORT Cash on Cash Yield Yield to Worst Current Yield Yield to Best CDS Spread Net Equity Delta Default Spread Beta Semideviation Sharpe Ratio Skewness Sortino Ratio Stress VaR/Stress Test Standard Deviation Profit-at-Risk Residual Risk 2017 Advise Technologies CONFIDENTIAL Page 12
Open Protocol Solvency II Form PF AIFMD CPO-PQR Form N-PORT Earnings-at-Risk Expected Shortfall/CVaR Inflation Beta Information Ratio Kurtosis Liquidity Adjusted Value at Risk Marginal Expected Shortfall Maximum Drawdown Omega Ratio Risk-Based Leverage Scenario Analysis 2017 Advise Technologies CONFIDENTIAL Page 13
REFERENCES 12.1 Solvency II Directive 2009/138/EC: http://eur-lex.europa.eu/legal-content/en/txt/pdf/?uri=celex:32009l0138&from=en Regulation 2015/35/EU: http://eur-lex.europa.eu/legal-content/en/txt/pdf/?uri=oj:l:2015:012:full&from=en 12.2 AIFMD Directive 2011/61/24: http://eur-lex.europa.eu/lexuriserv/lexuriserv.do?uri=oj:l:2011:174:0001:0073:en:pdf Regulation 231-2013: http://eur-lex.europa.eu/lexuriserv/lexuriserv.do?uri=oj:l:2013:083:0001:0095:en:pdf ESMA Opinion Guidelines: https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-869.pdf https://www.esma.europa.eu/sites/default/files/library/2015/11/2013-esma- 1340_opinion_on_collection_of_information_under_aifmd_for_publication.pdf 12.3 Form PF Form PF Paper Form: https://www.sec.gov/about/forms/formpf.pdf Dodd-Frank Legislation: http://www.cftc.gov/idc/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf Form PF Frequently Asked Questions: https://www.sec.gov/divisions/investment/pfrd/pfrdfaq.shtml 2017 Advise Technologies CONFIDENTIAL Page 14
12.4 CPO-PQR Pool Quarterly Report For Commodity Pool Operators: https://www.nfa.futures.org/easyfileplus/efptemplate.aspx?template=pqr 12.5 Open Protocol Template and Manual: http://www.theopenprotocol.org/top/thetemplateandmanual Frequently Asked Questions: http://www.theopenprotocol.org/top/faq 12.6 Form N-PORT Final Rule: Investment Company Reporting Modernization: https://www.sec.gov/rules/final/2016/33-10231.pdf CONTACT For more information, please contact: Data & Analytics Team Advise Technologies +1 (212) 576 1170 calcs@adviserms.com 2017 Advise Technologies CONFIDENTIAL Page 15