1. 1
RZ130
Risk assessments of retail investment
products in Hong Kong and mainland China
3 IFPHK CE credits
3 SFC CPT hours
3 MPFA non-core CPD hours
Speaker: Dr. LAM Yat Fai (㨦㡴战 ◩⭺)
Doctor of Business Administration (Finance)
CFA CAIA FRM PRM MCSE MCNE
6:30pm to 9:30pm Friday 19th July 2013
2
Outline
† Suitability of investment products
† Major investment products
† Qualitative risk assessment
† Quantitative risk assessment
† Practical issues
† Private banking and corporate banking
3
What is this investment product?
† Excellent investment product
„ High return
„ Low risk
„ Huge growth potential
„ Very stable income
„ As reliable as deposits
4
What is this investment product?
† Very popular investment product
„ Mr. LAM acquired HK$ 100,000 yesterday
„ Mrs. LEE further brought HK$ 500,000 this
morning
„ Subscription to be closed by this end of
today
„ Limited offer to very few VIPs like you
2. 5
What is this investment product?
† Today the market is going up
† The price will be more expensive
tomorrow
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What is this investment product?
† Today the market is going down
† The price is very attractive today
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Sure win selling strategy
† HK$ 100 Parknshop gift coupon for every
HK$ 100,000 subscription
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Very familiar conversions
3. 9
Whom are you talking to?
10
Whom are you talking to?
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Lehman Brothers minibonds
12
4. 13
Supervisory framework
† Zoning
† No gift
† Audio recording
† Code of conducts
† Investor education
† Key fact sheet
† Suitability assessment
† and many more
14
Suitability assessment
Suitability
assessment
Investor profiling Product assessment
Product risk level
Product features
Risk tolerance level
Know your client
15
Outline
† Suitability of investment products
† Major investment products
† Qualitative risk assessment
† Quantitative risk assessment
† Practical issues
† Private banking and corporate banking
16
Common investment
products in Hong Kong
† Retail
„ Investment funds
† Hedge funds
„ Bonds
„ Structured notes
† Principal protected notes
„ Currency linked deposits
„ Equity linked deposits
„ Insurance linked investment schemes
5. 17
Common investment
products in Hong Kong
† Private banking and corporate banking
„ Accumulator
„ Decumulator
„ Target redemption
„ Pivot
„ Currency linked notes with multiple
underlying and fixing
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Investment products in China
† Private placement lending
† Asset backed securities
Risk rating of RMB bonds
19
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6. 21
Risk rating of
common products
Products Level
Deposits 1
Government bonds 1 to 2
Corporate bonds 2 to 3
Currency linked deposits 3 to 4
Equity linked notes 4 to 5
Credit linked notes 5
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Outline
† Suitability of investment products
† Major investment products
† Qualitative risk assessment
† Quantitative risk assessment
† Practical issues
† Private banking and corporate banking
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Product risk assessment
Qualitative
† Expert judgment
† Subjective
† Time consuming
† Less consistent
† Very flexible
Quantitative
† Model based
† Objective
† Automated
† Consistent
† Less flexible
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Regulatory risk factors
† 6)&¶VNHIDFWVVWDWHPHQW
„ http://www.sfc.hk/web/EN/regulatory-functions/
products/product-authorization/
products-key-facts-statements.
html
† +.0$¶VLPSRUWDQWIDFWVVWDWHPHQW
„ http://www.hkma.gov.hk/media/eng/doc/key-information/
guidelines-and-circular/
2011/20110418e1.pdf
7. 25
Descriptive report
† Many lengthy paragraphs
„ broken down by risk type
„ to conclude a risk rating
† Several pages to several lines
† Very similar reports among similar
investment products
26
Score card
† Each risk factor is classified into one of
several risk types
„ 5 to 10 risk types
† (DFKULVNWSHLVDVVLJQHGDVFRUH³´WR
³´
„ 3 to 6 risk factors per type
† All scores are combined into a risk rating
according to some rules
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Qualitative assessment
† Experience oriented
† Subjective
† Less consistency
† Subject to manipulation
† Argument among various departments
† Time consuming
† Regular update on annual basis
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Outline
† Suitability of investment products
† Major investment products
† Qualitative risk assessment
† Quantitative risk assessment
† Practical issues
† Private banking and corporate banking
13. Volatility = Standard deviation Most recent 52 drifts 52
Extreme loss = 2.3264 × Volatility
36
Interest rate risk
† For investment with principal to be locked
in until maturity
† VaR at 99th percentile 1-year horizon
Drift = Interest rate this week
- Interest rate last week
14. Volatility = Standard deviation Most recent 52 drifts 52
Extreme loss = 2.3264 × Volatility × Maturity
16. AAA, AA 1.6 1.6 0
A 4 4 1.6
BBB 4 4 4
BB 8 8 8
B 12 8 8
CCC to C 12 12 12
Unrated 12 12 12
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Operational risk
† To capture the extreme loss as a
result of investment product
complexity
† Based on standardized approach,
Basel III
„ Low 12%
„ Medium 15%
„ High 18%
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Liquidity risk
† To capture the extreme loss as a result of
immediate liquidation
† Based on collateral haircut table, Basel
III
„ Exposure ± government vs corporate
„ Credit rating ± BB or above
„ Residual maturity
40
Collateral haircut table
25. 49
Practical issues
† Peer group comparison
† Sensitivity vs stability
† Product decomposition
† 2-dimensional rating
† New product
† New product category
† Marketing vs risk management
† Data
† Transition gap
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Peer comparison
† HSBC
† Hang Seng Bank
† DBS(HK)
† Wing Lung Bank
† Wing Hang Bank
† Bank of Communications
† ICBC(Asia)
† ANZI(HK)
51
Point-in-time vs
through-the-cycle
52
Product decomposition
† Different decomposition may result
different product rating
† CLD = Deposits ± Put option
„ Product rating = 4
† CLD = Worse of two short term bonds in
different currencies
„ Product rating = Max(1, 2) = 2
26. 53
2-dimensional rating
† Risk rating of insurance policy
„ ³$´³%´³´³'´³(´
† Risk rating of investments
„ ³´³´³´³´³´
† Risk rating of ILAS product
„ Insurance policy ~ Investments
„ A1, B2, A3, C4, B5
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New product
† New fund
„ Proxy by similar fund with sufficient history
† New equity
„ Proxy by similar equity with sufficient history
† No proxy
„ The highest historical rating in the category
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New product category
† New products
„ RMB bond
„ iBond
„ ILAS
„ CLDs with multiple underlying
† Product committee to design the rating
methodology
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Contradiction
† Marketing
„ Product rating as low as possible
„ Product information as little as possible
„ Less change on product rating
† Risk management
„ Product rating as high as possible
„ 3URGXFWUDWLQJ³´ZLWKLQVXIILFLHQWLQIRUPDWLRQ
„ More frequent update on product rating
27. 57
Data
† Manageable and easily accessible
„ Reuters and Bloomberg
„ Lipper and MorningStar
† Product data
„ From marketing department
† Financial market data
„ From ???
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Transition gap
† New risk ratings materially deviating from
existing ratings
„ Lower new ratings ± Good
„ Higher new ratings ± What to do?
† Should the sold products with mis-matches
be liquidated?
† Should I inform the mis-match to
customers
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Outline
† Suitability of investment products
† Major investment products
† Qualitative risk assessment
† Quantitative risk assessment
† Practical issues
† Private banking and corporate banking
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Private banking
† Customers with HK$ 8 mn liquid cash
† Portfolio with diversified investment product
components
† Investment risk assessed on portfolio basis
† How to quantify investment portfolio risk?
„ Dilution
„ Diversification
28. Corporate banking
† Corporate customers with higher risk in their
financial profile essentially demand
correspondingly higher risk hedging strategies
in offsetting direction so as to bring their
financial profile back to affordable risk levels
† Only corporate customers with sufficient
knowledge in financial instruments, who know
clearly the costs and benefits of different types
of hedging instruments, may choose to adopt
more complex hedging instruments, in order to
reduce the risk of their financial profile more
efficiently at a minimum cost
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Level of sophistication
† Level 1
„ Vanilla currency and interest rate derivatives without optionality
† Level 2
„ Vanilla currency options and interest rate derivatives with
optionality
† Level 3
„ Currency options and interest rate derivatives with exotic
payoffs
† Level 4
„ Any hedging instruments falling outside Levels 1, 2, 3 and 5
† Level 5
„ Hedging instruments which are only allowed to be acquired by
professional investors under the regulatory guidelines from the
HKMA and/or SFC, e.g. accumulators
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Further complication
† Asset class
† Short selling
† Credit line
† Collateral
29. 65
Q A
66
Thank You
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