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Product Taxonomy & Model Risk Management: 'Putting the Beans back into Coffee'

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This was a presentation at the 6th Annual Stress Testing conference on 2 Dec 2011 in London.

This was a presentation at the 6th Annual Stress Testing conference on 2 Dec 2011 in London.


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  • 1. PRODUCT TAXONOMY &MODEL RISK MANAGEMENT:‘Putting the beans back into coffee’Markus Krebsz6th Annual Stress Testing Conference30 Nov - 2 Dec 2011, London
  • 2. PRODUCT TAXONOMY ‘Putting the beans.. ..back into coffee’ 2
  • 3. DEFINITION & STRUCTUREΤάξις = taxis (meaning order or arrangement) and νόμος = nomos (meaning law’) 3
  • 4. WHY? Risk modeling & Stress testing Valuation & P+L explain PRODUCT Certification & Model control Risk Reporting & Management 4
  • 5. OBJECTIVE ‘COMPLETE MENU’ Fully classified product suite across the firm: i.e. Fixed Income, Equities, F/X, Structured Rates & Credit, Commodities divisions Ability to model Risks & monitor Model performance: Models, Model data, Product certifications, Valuation adjustments and P+L explain 5
  • 6. OBJECTIVE (External / Regulatory drivers) Bank for International Settlements/ Financial Stability Board: Senior Supervisors Group’s white paper of the “Observations on developments in risk appetite frameworks and IT infrastructure” – Dec . 2010 Financial Services Authority (UK): - ‘Dear CEO letter’ entitled “Valuation and product control” – Aug. 2008 - New assessment framework for prudent valuation to promote a more systematic approach to the assessment of valuation uncertainty and prudent valuation. - BIPRU 7.10 – Use of VaR-models prescribing 4 different types of products - FSA is also likely going to assess granular judgmental analysis by firms at product level. Dodd-Frank act (US): introduces several new concepts to derivatives processing: - Taxonomy, identifies the type of traded product (e.g. simple EQ option) - Unique product identifiers (UPI), identifies traded product (e.g. a 5Y-USD-LIBOR interest rate swap) – but not necessarily a specific contract - Standardised product, i.e. derivatives products that have standard terms and are listed on an execution platform International Swaps and Derivatives Association 6
  • 7. CONCEPTUAL MODELImportant: Mandatory vs. Product-specific nodes - Mandatory nodes apply to all products, regardless of the asset class - Product-specific nodes are not always populated Product-specific vs. Trade-specific features - a Cappuccino to ‘drink-in’ vs. ‘Take-away’  the product is the same Based on observable trade facts & the lowest level of ‘product’ 7
  • 8. CLASSIFICATION APPROACH Vanilla Structured Exotic < Flow products > < Templated > < Non-templated >‘Locked-down’ Building blocks Freely scripted = Tea-Bag = Hot water + Espresso = Cappuccino with Soy milk, + Semi-skimmed milk fair-trade coffee, sugar-free Hazelnut syrup and…System-compiled Template-driven Human-compiled 8
  • 9. TAXONOMY DEVELOPMENT CYCLE Determine Identify Develop draft requirements concepts taxonomy Scope?; Purpose? ; Type of content Where and what is the content?; Develop upper taxonomy levels: format?; Target audience & users?; Perform content inventory; Start broad, not deep; Bottom up Business objectives? Conduct user interviews and/or top down approach  Business case document,  Identify “high value”  Establish common rules Scope statement, Project plan, content for: Taxonomy format, Issue log Structure & Relationship, Guidelines & standards Review with SMEs Refine Apply taxonomy Manage & Maintain & Users taxonomy taxonomy to contentIdentify appropriate SMEs for Iterative process; Incorporate Integrate taxonomy globally Establish taxonomy ownership,taxonomy validation user feedback; Living/growing across firm with existing governance & Change control tool, i.e. never finished applications; Associate process; Conduct periodic review Does structure make taxonomy terms with to establish if it still “fits” sense?  But: stop when good products; Address links to Does it go too deep? “enough” and Observe other concepts  Documentation, Ongoing Are all major products balance: Value vs. detail  Provide guidelines for review, approval and change included? use, application and implementation, Version control Are there any gaps? training for users 9
  • 10. CHALLENGES 10
  • 11. BENEFITS Meeting a large selection of cross-functional requirements enabling - Model control & Stress testing - Model certifications - Product control - Management of Trading mandate - P+L explain - Proper valuation adjustments and management of model reserves Greater transparency and comparability of (derivative) products Post-trade transparency is ticking the Regulators’ ‘boxes’ 11
  • 12. CLOSEThank you very muchfor your attention, contribution and listening today!________________________________________________________________________________CONTACT:+ 44 (0) 79 85 065 045www.riskguide.net www.markuskrebsz.info 12
  • 13. Markus KrebszSubject matter expert : Rating agencies & Securitisation • Freelance Consultant with nineteen years experience in banking & financial institutions - thereof ten years covering rating agencies • Credit rating advisor for the World Bank as part of various large-scale projects involving GSEs of several African & Asian nations • Industry expert in credit rating agency as well as Structured finance-related issues and frequent speaker on international conferences • Author and passionate reviewer/editor of several risk workbooks • Frequent contributor to various industry working groups consulting regulators, exchanges and central banksPublications • ‘Securitisation & Structured Finance post Credit Crunch: A Best Practice Deal Lifecycle Guide’, John Wiley & Sons Inc., Apr. 2011 • ‘Product Taxonomy: A Key Tool for Understanding Risk/Return within the Banking Framework’ Qfinance chapter, exp. Jan 2012 • ‘Investor Requirements for 2011 and beyond: Due diligence and Risk analysis in a post-crisis world’, Euromoney Yearbook chapter • Workbooks of the Chartered Institute for Securities & Investments (CISI): ‘Derivatives’ (Senior Reviewer), ‘IT in Investment Operations’, (Senior reviewer), ‘Operational Risk’ , (Senior reviewer) & ‘Risk in Financial Services’, (Technical Reviewer) • ‘Frontiers of Risk management – Chapter 14: Credit rating agencies and the IRB approach’, Euromoney Book, 2007 • Numerous special, research and criteria reports on Fitch Rating’s website as Performance & Rating analyst, Aug 2004 to Oct 2006 • SAP Risk Analyzer Manual (in-house publication, in German), Jan 2002Professional qualifications & affiliations Assignments (Past & current) • Individually Chartered Member of the Chartered • The World Bank Securities and Investment Institute (CISI) • Deutsche Bank & UBS • Bachelor of Banking Services and Operations, CCI • Lloyds Banking Group • ‘Train the Trainers’ Certificate • Bank of Scotland Treasury • ‘Banking in Britain’ Certificate • The Royal Bank of Scotland Group • German Banking Certificate (‘Bankkaufmann’) • HypoVereinsbank / Unicredit • Volunteer at and Member of the Professional Risk • Dresdner Bank Manager’s International Association (PRMIA) • Primary insight (Subsidiary of Bear Stearns) • Member of the Global Association of Risk • De Matteo Monness (Subsidiary of Goldman Sachs) Professionals (GARP) • Fitch Ratingswww.markuskrebsz.info / www.markuskrebsz.co.uk • Vista Research (Subsidiary of Standard & Poor’s) 13
  • 14. APPENDIX: Further references 14
  • 15. FURTHER REFERENCESBook:Krebsz, Markus. Securitization and Structured Finance post Credit Crunch: A BestPractice Deal Lifecyle Guide, Wiley, 2011.Some chapters are available to browse/read online at Google books:http://books.google.com/books?id=28mO9cjAWwsC&printsec=frontcover&source=gbs_atb#v=onepage&q&f=falseArticles:Bank for International Settlements (BIS) Financial Stability Board. “Observations ondevelopments in risk appetite frameworks and IT infrastructure.” BIS, December 23,2010. Online: www.fsa.gov.uk/pubs/other/ssg_2010.pdfBennett, M. “Financial securities ontology.” Hypercube Ltd., May 2007. Online:www.hypercube.co.uk/docs/ontologyexploration.docInternational Swaps and Derivatives Association (ISDA). “Product representation forstandardized derivatives.” White paper, April 14, 2011. Online:www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission_042111_706_0.pdf 15
  • 16. FURTHER REFERENCES (cont.)International Swaps and Derivatives Association (ISDA). “Implementation plan forunique product identifiers.” June 30, 2011.Online: www.fpml.org/_wgmail/_eqdwgmail/pdfRK0ZIeMu8T.pdfSants, H. “Dear CEO: Valuation and product control.” Financial Services Authority,August 13, 2008. Online: www.fsa.gov.uk/pubs/ceo/valuation.pdfWhittaker, M., and Breininger, K. “Taxonomy development for knowledgemanagement.” Presented at World Library and Information Congress, 74th IFLAGeneral Conference and Council, Quebec, Canada, August 10–14, 2008.Online: http://archive.ifla.org/IV/ifla74/papers/138-Whittaker_Breininger-en.pdfWebsites:HandCoded Software Ltd.: www.handcoded.comEnterprise Data Management (EDM) Council’s “Semantics Repository.”www.edmcouncil.org/sec_semantics.aspxTaxonomy Strategies—information management consultancy that specializes inapplying taxonomies, metadata and automatic classification:www.taxonomystrategies.com 16
  • 17. AND FINALLY… More on Asset/product classification, Risk & rating models, Model risk and Analytical tools is in my latest book ‘Securitization and Structured Finance post Credit Crunch – A Best Practice Deal Lifecycle Guide.’ A special offer for a 30% discount (of the RRP) for orders is currently available for a limited time only, if the order is placed directly at the publishers website www.wiley.com and the promotion code VA817 is entered. Thank you for your interest. 17