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The	
  raft	
  of	
  post-­‐crash	
  capital	
  adequacy	
  regulations	
  and	
  demands	
  for	
  increased	
  
transparency	
  mean	
  that	
  banks,	
  pension	
  funds	
  and	
  trading	
  desks	
  -­‐	
  some	
  in-­‐house	
  at	
  
large	
  treasuries	
  -­‐	
  are	
  having	
  to	
  carry	
  out	
  extensive	
  de-­‐risking	
  exercises.	
  The	
  
increased	
  reporting	
  requirements	
  should	
  theoretically	
  make	
  it	
  easier	
  for	
  treasurers	
  
to	
  assess	
  bank	
  and	
  counterparty	
  exposure	
  risk,	
  pension	
  exposures	
  and	
  other	
  risks,	
  
but	
  is	
  this	
  happening	
  in	
  reality?	
  A	
  risk	
  management	
  protocol	
  is	
  essential	
  to	
  be	
  able	
  
to	
  tell	
  and	
  to	
  ensure	
  best	
  practice.	
  

With	
  the	
  majority	
  of	
  financial	
  institutions	
  and	
  regulated	
  pension	
  funds	
  undertaking	
  
extensive	
  de-­‐risking	
  of	
  their	
  respective	
  trading	
  portfolios,	
  it	
  is	
  imperative	
  that	
  robust	
  
risk	
  frameworks	
  are	
  in	
  place	
  to	
  ensure	
  that	
  all	
  aspects	
  of	
  the	
  portfolio	
  are	
  managed	
  
in	
  a	
  transparent	
  and	
  efficient	
  way,	
  particularly	
  in	
  terms	
  of	
  asset	
  diversification.	
  
Financial	
  institutions'	
  balance	
  sheets	
  are	
  currently	
  undergoing	
  major	
  asset	
  
reductions	
  in	
  order	
  to	
  achieve	
  their	
  regulatory	
  capital	
  requirements,	
  without	
  
compromising	
  their	
  core	
  business	
  revenue	
  targets.	
  Given	
  these	
  regulatory	
  demands,	
  
it	
  is	
  now	
  more	
  crucial	
  than	
  ever	
  to	
  ensure	
  that	
  adequate	
  investment	
  in	
  process,	
  
controls	
  and	
  systems	
  is	
  maintained	
  in	
  order	
  to	
  achieve	
  the	
  accuracy,	
  timely	
  risk,	
  
position	
  reporting	
  and	
  benchmarking	
  for	
  both	
  management	
  and	
  regulatory	
  
disclosure.	
  

Trading	
  desks	
  are	
  being	
  assessed	
  not	
  only	
  on	
  the	
  revenue	
  that	
  they	
  produce	
  but	
  also	
  
on	
  the	
  capital	
  utilisation	
  being	
  used	
  to	
  achieve	
  this	
  income.	
  This	
  requires	
  risk	
  
managers	
  within	
  their	
  respective	
  organisations	
  to	
  work	
  closely	
  with	
  the	
  business	
  
across	
  all	
  risk	
  functions	
  and	
  asset	
  classes.	
  They	
  need	
  to	
  analyse	
  the	
  specific	
  
concentrations	
  and	
  diversifications	
  in	
  order	
  to	
  determine	
  the	
  most	
  appropriate	
  de-­‐
risking	
  and	
  hedging	
  strategies	
  to	
  be	
  implemented.	
  This	
  can	
  only	
  be	
  effectively	
  
achieved	
  with	
  the	
  existence	
  of	
  a	
  comprehensive	
  risk	
  framework	
  that	
  empowers	
  
policies	
  to	
  incorporate	
  updated	
  regulatory	
  requirements	
  and	
  the	
  risk	
  appetite	
  of	
  the	
  
institution.	
  

Risk	
  Framework	
  Objectives	
  

The	
  overall	
  objective	
  of	
  any	
  risk	
  framework	
  is	
  to	
  ensure	
  that	
  all	
  regulatory	
  
requirements	
  are	
  maintained,	
  without	
  impinging	
  on	
  the	
  commercial	
  needs	
  of	
  the	
  
business.	
  At	
  the	
  same	
  time,	
  it	
  needs	
  to	
  be	
  scaled	
  appropriately	
  against	
  the	
  risk	
  
appetite	
  of	
  the	
  organisation's	
  board	
  of	
  directors.	
  With	
  this	
  in	
  mind	
  it	
  is	
  important	
  to	
  
ensure	
  that	
  a	
  'best-­‐in-­‐class'	
  risk	
  framework	
  is	
  used	
  and	
  to	
  be	
  confident	
  that	
  this	
  
framework	
  has	
  the	
  ability	
  to	
  produce	
  transparency	
  and	
  accurate	
  reporting	
  of	
  the	
  risk	
  
portfolio.	
  That	
  way	
  an	
  analysis	
  of	
  de-­‐risking	
  strategies	
  can	
  be	
  accurately	
  carried	
  out	
  
for	
  management	
  consumption.	
  



                                                                                                                                   1	
  
An	
  organisation's	
  risk	
  framework	
  has	
  to	
  be	
  reviewed	
  periodically	
  across	
  both	
  policies	
  
and	
  procedures	
  in	
  order	
  to	
  ensure	
  that	
  all	
  aspects	
  of	
  the	
  business	
  are	
  clear	
  on	
  the	
  
ownership	
  of	
  risk,	
  along	
  with	
  the	
  governance	
  structure	
  and	
  standards	
  of	
  measuring,	
  
monitoring	
  and	
  reporting	
  on	
  an	
  accurate	
  and	
  timely	
  basis.	
  The	
  delivery	
  of	
  an	
  
appropriate	
  risk	
  framework	
  essentially	
  enables	
  an	
  organisation	
  to	
  meet	
  its	
  
regulatory	
  requirements	
  while	
  facilitating	
  the	
  business	
  needs	
  of	
  its	
  trading	
  desks,	
  in-­‐
line	
  with	
  the	
  risk-­‐reward	
  appetite	
  in	
  order	
  to	
  achieve	
  defined	
  revenue	
  targets.	
  

The	
  risk	
  strategies	
  and	
  the	
  risk-­‐bearing	
  capacity	
  of	
  an	
  organisation	
  for	
  the	
  individual	
  
business	
  divisions	
  needs	
  to	
  be	
  consistent	
  and	
  continually	
  developed	
  as	
  part	
  of	
  an	
  
interactive	
  process.	
  The	
  regulatory	
  environment	
  has	
  matured	
  considerably	
  in	
  recent	
  
years	
  in	
  this	
  regard,	
  with	
  organisations	
  now	
  required	
  to	
  articulate	
  and	
  report	
  on	
  
their	
  risk-­‐bearing	
  capacity,	
  risk	
  strategy	
  and	
  risk	
  appetite	
  as	
  part	
  of	
  the	
  Basel	
  II	
  
requirement	
  of	
  the	
  Internal	
  Capital	
  Adequacy	
  Assessment	
  Process	
  (ICAAP).	
  Basel	
  III	
  is	
  
on	
  the	
  way	
  as	
  well.	
  

The	
  Core	
  Principles	
  of	
  Risk	
  Management	
  

The	
  management	
  of	
  risk	
  can	
  be	
  defined	
  through	
  the	
  following	
  core	
  principles:	
  

     •     Ownership.	
  
     •     Integration.	
  
     •     Alignment.	
  
     •     Transparency.	
  
     •     Engagement	
  and	
  approval	
  authority.	
  

Incorporating	
  these	
  principles	
  into	
  a	
  robust	
  risk	
  framework	
  enables	
  an	
  organisation	
  
to	
  de-­‐risk	
  and	
  manage	
  its	
  capital	
  requirements	
  across	
  all	
  asset	
  classes	
  effectively	
  and	
  
efficiently.	
  

Within	
  the	
  risk	
  framework,	
  it	
  is	
  the	
  responsibility	
  of	
  each	
  trading	
  desk,	
  fund	
  manager	
  
or	
  business	
  area,	
  which	
  may	
  include	
  some	
  treasurers	
  at	
  advanced	
  multinationals	
  
that	
  look	
  to	
  profit	
  from	
  their	
  hedging	
  activities,	
  to	
  manage	
  their	
  risk	
  exposures.	
  Both	
  
the	
  hedging/de-­‐risking	
  strategies	
  and	
  positions	
  that	
  they	
  implement	
  are	
  a	
  
fundamental	
  component	
  of	
  ownership	
  and	
  responsibility,	
  providing	
  the	
  framework	
  
on	
  which	
  a	
  trading	
  portfolio	
  can	
  be	
  hedged	
  or	
  positions	
  closed	
  for	
  de-­‐risking,	
  on	
  
either	
  a	
  micro	
  or	
  a	
  more	
  high-­‐level	
  management	
  of	
  exposures	
  across	
  a	
  business	
  line.	
  
Ultimately,	
  the	
  responsibility	
  for	
  implementing	
  any	
  de-­‐risking	
  strategy	
  lies	
  with	
  the	
  
individual	
  business	
  line	
  manager	
  or	
  fund	
  manager	
  on	
  a	
  daily	
  basis,	
  and	
  with	
  central	
  
management	
  or	
  the	
  board	
  at	
  the	
  very	
  top	
  level.	
  

The	
  Fundamentals	
  of	
  the	
  Review	
  Process	
  

As	
  part	
  of	
  their	
  primary	
  function,	
  risk	
  managers	
  should	
  undertake	
  a	
  review	
  of	
  the	
  de-­‐
risking	
  strategies	
  that	
  are	
  being	
  undertaken,	
  at	
  either	
  a	
  macro	
  level	
  or	
  business	
  line,	
  
or	
  on	
  a	
  daily	
  basis	
  within	
  the	
  trading	
  group	
  in	
  order	
  to	
  determine	
  both	
  concentration	
  


                                                                                                                                  2	
  
and	
  diversification	
  effects.	
  When	
  performing	
  such	
  reviews	
  of	
  de-­‐risking	
  strategies,	
  a	
  
number	
  of	
  considerations	
  need	
  to	
  be	
  taken	
  into	
  consideration;	
  such	
  as	
  the	
  choice	
  of	
  
instrument,	
  the	
  size	
  of	
  the	
  hedging	
  position,	
  market	
  liquidity	
  and	
  concentration,	
  and	
  
the	
  degree	
  of	
  basis	
  risk	
  between	
  the	
  underlying	
  and	
  hedging	
  instrument,	
  along	
  with	
  
timing	
  factors	
  for	
  implementation	
  of	
  the	
  de-­‐risking	
  strategy.	
  This	
  is	
  even	
  more	
  
relevant	
  to	
  fund	
  managers	
  where	
  concentration	
  risk	
  in	
  industry	
  sectors,	
  countries	
  
and	
  counterparties	
  can	
  make	
  de-­‐risking	
  difficult	
  to	
  achieve	
  in	
  a	
  short	
  period	
  due	
  to	
  
market	
  conditions	
  and	
  liquidity.	
  

Where	
  de-­‐risking	
  is	
  being	
  performed,	
  risk	
  managers	
  also	
  need	
  to	
  weigh	
  up	
  the	
  
individual	
  capital	
  impacts	
  on	
  credit,	
  market,	
  liquidity	
  and	
  operational	
  charges,	
  along	
  
with	
  the	
  diversification	
  and	
  concentration	
  effects	
  across	
  the	
  portfolio	
  in	
  respect	
  of	
  
the	
  asset	
  classes.	
  Where	
  concentration	
  risks	
  arise,	
  either	
  as	
  holding	
  positions	
  with	
  
similar	
  characteristics	
  to	
  a	
  significant	
  size,	
  or	
  an	
  adverse	
  development	
  of	
  a	
  limited	
  
number	
  of	
  risk	
  factors,	
  this	
  could	
  lead	
  to	
  both	
  a	
  significant	
  loss	
  and	
  major	
  capital	
  
requirement	
  under	
  current	
  regulatory	
  rules.	
  

Defining	
  Risk	
  Appetite	
  and	
  Strategy	
  

Given	
  these	
  potentially	
  dangerous	
  and	
  unwanted	
  outcomes,	
  it	
  is	
  important	
  that	
  the	
  
appropriate	
  governance	
  and	
  supervision	
  that	
  the	
  risk	
  framework	
  provides	
  is	
  
matched	
  to	
  the	
  overall	
  risk	
  appetite	
  and	
  strategy	
  set	
  by	
  senior	
  management.	
  By	
  
establishing	
  limits	
  and	
  monitoring,	
  an	
  organisation	
  is	
  guaranteed	
  the	
  key	
  control	
  and	
  
transparency	
  needed	
  to	
  manage	
  both	
  the	
  portfolio	
  and	
  capital	
  requirements	
  
effectively.	
  The	
  use	
  of	
  key	
  metrics,	
  such	
  as	
  economic	
  capital,	
  value-­‐at-­‐risk	
  (VaR),	
  
stress	
  testing,	
  sensitivity	
  and	
  position	
  limits,	
  credit	
  and	
  default	
  limits	
  and	
  
concentration	
  risk,	
  combined	
  with	
  robust,	
  accurate	
  and	
  timely	
  reporting,	
  effectively	
  
allows	
  an	
  organisation	
  to	
  de-­‐risk	
  appropriately.	
  

On	
  the	
  reporting	
  of	
  de-­‐risking	
  strategies,	
  such	
  as	
  the	
  implementation	
  of	
  hedge	
  
positions,	
  it	
  is	
  important	
  that	
  the	
  calculations	
  used	
  in	
  determining	
  the	
  risk	
  are	
  easily	
  
decomposed	
  at	
  each	
  stage	
  of	
  the	
  risk	
  reporting	
  process	
  to	
  give	
  transparency	
  and	
  
validation.	
  Risk	
  managers	
  often	
  request	
  macro	
  hedges	
  to	
  be	
  segregated,	
  to	
  enable	
  
more	
  accurate	
  monitoring	
  of	
  the	
  de-­‐risking	
  strategy	
  as	
  well	
  as	
  standalone	
  analysis	
  to	
  
be	
  undertaken.	
  

Within	
  a	
  robust	
  risk	
  framework,	
  reporting	
  principles	
  such	
  as	
  standardised	
  reporting	
  
platform,	
  materiality	
  and	
  relevance	
  of	
  reports,	
  production	
  scalability	
  and	
  flexibility	
  
along	
  with	
  infrastructure	
  enhancement	
  are	
  required	
  to	
  enable	
  efficient	
  risk	
  
management	
  to	
  undertake	
  both	
  de-­‐risking	
  and	
  hedging	
  strategies.	
  This	
  has	
  become	
  
paramount	
  over	
  recent	
  years	
  with	
  the	
  regulatory	
  requirements	
  of	
  both	
  Basel	
  II	
  and	
  
III,	
  and	
  the	
  Capital	
  Requirement	
  Directive	
  (CRD3),	
  coupled	
  with	
  every	
  organisation	
  
attempting	
  to	
  rebalance	
  their	
  respective	
  balance	
  sheets	
  by	
  focusing	
  on	
  their	
  core	
  
businesses.	
  Don't	
  forget	
  either	
  that	
  the	
  final	
  CRD4	
  proposals,	
  associated	
  with	
  the	
  
incoming	
  Basel	
  III	
  changes,	
  are	
  due	
  to	
  be	
  unveiled	
  in	
  Europe	
  next	
  year.	
  



                                                                                                                                 3	
  
Senior	
  management	
  is	
  now	
  more	
  focused	
  on	
  analysing	
  the	
  drivers	
  and	
  diversification	
  
affect	
  that	
  macro	
  hedges	
  have	
  across	
  the	
  portfolio,	
  on	
  the	
  basis	
  of	
  managing	
  the	
  risk	
  
weighted	
  assets	
  (RWA)	
  for	
  capital	
  efficiency	
  effectively.	
  This	
  has	
  created	
  an	
  
operational	
  strain	
  on	
  risk	
  infrastructures,	
  in	
  order	
  to	
  produce	
  and	
  maintain	
  
transparent	
  and	
  accurate	
  reporting,	
  especially	
  for	
  regulatory	
  requirements.	
  This	
  puts	
  
further	
  emphasis	
  on	
  the	
  need	
  for	
  an	
  infrastructure	
  that	
  provides	
  timely,	
  transparent	
  
and	
  accurate	
  reporting	
  of	
  the	
  risk	
  portfolio,	
  to	
  support	
  de-­‐risking	
  decisions	
  in	
  an	
  
effective	
  and	
  efficient	
  manner	
  by	
  senior	
  management.	
  

The	
  steep	
  demands	
  of	
  the	
  CRD3	
  changes,	
  such	
  as	
  stressed	
  VaR	
  and	
  incremental	
  risk	
  
charge	
  (IRC)	
  on	
  a	
  timely	
  basis	
  for	
  regulatory	
  reporting,	
  have	
  impacted	
  the	
  vast	
  
majority	
  of	
  institutions.	
  Their	
  ability	
  to	
  leverage	
  their	
  current	
  risk	
  framework	
  is	
  no	
  
longer	
  feasible	
  due	
  to	
  capacity	
  constraints	
  on	
  the	
  systems'	
  infrastructure.	
  In	
  turn,	
  
this	
  has	
  dictated	
  the	
  need	
  for	
  a	
  greater	
  integration	
  of	
  risk	
  reporting	
  within	
  the	
  
organisation's	
  hierarchy,	
  combined	
  with	
  the	
  flexibility	
  to	
  undertake	
  scenario	
  analysis	
  
to	
  determine	
  the	
  diversification	
  impact	
  of	
  macro	
  hedging.	
  

Robust	
  processes	
  and	
  systems	
  are	
  essential	
  for	
  accurate	
  and	
  timely	
  risk	
  reports,	
  
combined	
  with	
  the	
  ability	
  for	
  increased	
  capacity	
  of	
  usage	
  at	
  all	
  levels	
  of	
  the	
  business.	
  
This	
  requirement	
  has	
  necessitated	
  further	
  investment	
  in	
  the	
  current	
  infrastructure,	
  
together	
  with	
  ensuring	
  transparency	
  of	
  the	
  risk	
  factors	
  being	
  used	
  in	
  both	
  VaR	
  and	
  
economic	
  capital	
  calculations,	
  if	
  the	
  de-­‐risking	
  and	
  capital	
  management	
  strategies	
  
are	
  to	
  be	
  effective.	
  

Overall,	
  it	
  is	
  important	
  that	
  institutions	
  have	
  a	
  robust	
  risk	
  framework	
  in	
  place	
  to	
  
provide	
  management	
  and	
  the	
  business	
  with	
  the	
  transparency	
  needed	
  to	
  enable	
  
efficient	
  de-­‐risking	
  to	
  be	
  performed.	
  That	
  being	
  said,	
  the	
  significance	
  of	
  a	
  robust	
  
systems	
  infrastructure	
  cannot	
  be	
  underestimated,	
  complete	
  with	
  the	
  appropriate	
  
controls	
  and	
  capacity	
  to	
  facilitate	
  these	
  requirements.	
  Only	
  then	
  can	
  it	
  be	
  managed	
  
efficiently	
  with	
  timely	
  and	
  accurate	
  reporting	
  in	
  place.	
  

	
  




                                                                                                                                   4	
  

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Portfolio Risk Challenges

  • 1.   The  raft  of  post-­‐crash  capital  adequacy  regulations  and  demands  for  increased   transparency  mean  that  banks,  pension  funds  and  trading  desks  -­‐  some  in-­‐house  at   large  treasuries  -­‐  are  having  to  carry  out  extensive  de-­‐risking  exercises.  The   increased  reporting  requirements  should  theoretically  make  it  easier  for  treasurers   to  assess  bank  and  counterparty  exposure  risk,  pension  exposures  and  other  risks,   but  is  this  happening  in  reality?  A  risk  management  protocol  is  essential  to  be  able   to  tell  and  to  ensure  best  practice.   With  the  majority  of  financial  institutions  and  regulated  pension  funds  undertaking   extensive  de-­‐risking  of  their  respective  trading  portfolios,  it  is  imperative  that  robust   risk  frameworks  are  in  place  to  ensure  that  all  aspects  of  the  portfolio  are  managed   in  a  transparent  and  efficient  way,  particularly  in  terms  of  asset  diversification.   Financial  institutions'  balance  sheets  are  currently  undergoing  major  asset   reductions  in  order  to  achieve  their  regulatory  capital  requirements,  without   compromising  their  core  business  revenue  targets.  Given  these  regulatory  demands,   it  is  now  more  crucial  than  ever  to  ensure  that  adequate  investment  in  process,   controls  and  systems  is  maintained  in  order  to  achieve  the  accuracy,  timely  risk,   position  reporting  and  benchmarking  for  both  management  and  regulatory   disclosure.   Trading  desks  are  being  assessed  not  only  on  the  revenue  that  they  produce  but  also   on  the  capital  utilisation  being  used  to  achieve  this  income.  This  requires  risk   managers  within  their  respective  organisations  to  work  closely  with  the  business   across  all  risk  functions  and  asset  classes.  They  need  to  analyse  the  specific   concentrations  and  diversifications  in  order  to  determine  the  most  appropriate  de-­‐ risking  and  hedging  strategies  to  be  implemented.  This  can  only  be  effectively   achieved  with  the  existence  of  a  comprehensive  risk  framework  that  empowers   policies  to  incorporate  updated  regulatory  requirements  and  the  risk  appetite  of  the   institution.   Risk  Framework  Objectives   The  overall  objective  of  any  risk  framework  is  to  ensure  that  all  regulatory   requirements  are  maintained,  without  impinging  on  the  commercial  needs  of  the   business.  At  the  same  time,  it  needs  to  be  scaled  appropriately  against  the  risk   appetite  of  the  organisation's  board  of  directors.  With  this  in  mind  it  is  important  to   ensure  that  a  'best-­‐in-­‐class'  risk  framework  is  used  and  to  be  confident  that  this   framework  has  the  ability  to  produce  transparency  and  accurate  reporting  of  the  risk   portfolio.  That  way  an  analysis  of  de-­‐risking  strategies  can  be  accurately  carried  out   for  management  consumption.   1  
  • 2. An  organisation's  risk  framework  has  to  be  reviewed  periodically  across  both  policies   and  procedures  in  order  to  ensure  that  all  aspects  of  the  business  are  clear  on  the   ownership  of  risk,  along  with  the  governance  structure  and  standards  of  measuring,   monitoring  and  reporting  on  an  accurate  and  timely  basis.  The  delivery  of  an   appropriate  risk  framework  essentially  enables  an  organisation  to  meet  its   regulatory  requirements  while  facilitating  the  business  needs  of  its  trading  desks,  in-­‐ line  with  the  risk-­‐reward  appetite  in  order  to  achieve  defined  revenue  targets.   The  risk  strategies  and  the  risk-­‐bearing  capacity  of  an  organisation  for  the  individual   business  divisions  needs  to  be  consistent  and  continually  developed  as  part  of  an   interactive  process.  The  regulatory  environment  has  matured  considerably  in  recent   years  in  this  regard,  with  organisations  now  required  to  articulate  and  report  on   their  risk-­‐bearing  capacity,  risk  strategy  and  risk  appetite  as  part  of  the  Basel  II   requirement  of  the  Internal  Capital  Adequacy  Assessment  Process  (ICAAP).  Basel  III  is   on  the  way  as  well.   The  Core  Principles  of  Risk  Management   The  management  of  risk  can  be  defined  through  the  following  core  principles:   • Ownership.   • Integration.   • Alignment.   • Transparency.   • Engagement  and  approval  authority.   Incorporating  these  principles  into  a  robust  risk  framework  enables  an  organisation   to  de-­‐risk  and  manage  its  capital  requirements  across  all  asset  classes  effectively  and   efficiently.   Within  the  risk  framework,  it  is  the  responsibility  of  each  trading  desk,  fund  manager   or  business  area,  which  may  include  some  treasurers  at  advanced  multinationals   that  look  to  profit  from  their  hedging  activities,  to  manage  their  risk  exposures.  Both   the  hedging/de-­‐risking  strategies  and  positions  that  they  implement  are  a   fundamental  component  of  ownership  and  responsibility,  providing  the  framework   on  which  a  trading  portfolio  can  be  hedged  or  positions  closed  for  de-­‐risking,  on   either  a  micro  or  a  more  high-­‐level  management  of  exposures  across  a  business  line.   Ultimately,  the  responsibility  for  implementing  any  de-­‐risking  strategy  lies  with  the   individual  business  line  manager  or  fund  manager  on  a  daily  basis,  and  with  central   management  or  the  board  at  the  very  top  level.   The  Fundamentals  of  the  Review  Process   As  part  of  their  primary  function,  risk  managers  should  undertake  a  review  of  the  de-­‐ risking  strategies  that  are  being  undertaken,  at  either  a  macro  level  or  business  line,   or  on  a  daily  basis  within  the  trading  group  in  order  to  determine  both  concentration   2  
  • 3. and  diversification  effects.  When  performing  such  reviews  of  de-­‐risking  strategies,  a   number  of  considerations  need  to  be  taken  into  consideration;  such  as  the  choice  of   instrument,  the  size  of  the  hedging  position,  market  liquidity  and  concentration,  and   the  degree  of  basis  risk  between  the  underlying  and  hedging  instrument,  along  with   timing  factors  for  implementation  of  the  de-­‐risking  strategy.  This  is  even  more   relevant  to  fund  managers  where  concentration  risk  in  industry  sectors,  countries   and  counterparties  can  make  de-­‐risking  difficult  to  achieve  in  a  short  period  due  to   market  conditions  and  liquidity.   Where  de-­‐risking  is  being  performed,  risk  managers  also  need  to  weigh  up  the   individual  capital  impacts  on  credit,  market,  liquidity  and  operational  charges,  along   with  the  diversification  and  concentration  effects  across  the  portfolio  in  respect  of   the  asset  classes.  Where  concentration  risks  arise,  either  as  holding  positions  with   similar  characteristics  to  a  significant  size,  or  an  adverse  development  of  a  limited   number  of  risk  factors,  this  could  lead  to  both  a  significant  loss  and  major  capital   requirement  under  current  regulatory  rules.   Defining  Risk  Appetite  and  Strategy   Given  these  potentially  dangerous  and  unwanted  outcomes,  it  is  important  that  the   appropriate  governance  and  supervision  that  the  risk  framework  provides  is   matched  to  the  overall  risk  appetite  and  strategy  set  by  senior  management.  By   establishing  limits  and  monitoring,  an  organisation  is  guaranteed  the  key  control  and   transparency  needed  to  manage  both  the  portfolio  and  capital  requirements   effectively.  The  use  of  key  metrics,  such  as  economic  capital,  value-­‐at-­‐risk  (VaR),   stress  testing,  sensitivity  and  position  limits,  credit  and  default  limits  and   concentration  risk,  combined  with  robust,  accurate  and  timely  reporting,  effectively   allows  an  organisation  to  de-­‐risk  appropriately.   On  the  reporting  of  de-­‐risking  strategies,  such  as  the  implementation  of  hedge   positions,  it  is  important  that  the  calculations  used  in  determining  the  risk  are  easily   decomposed  at  each  stage  of  the  risk  reporting  process  to  give  transparency  and   validation.  Risk  managers  often  request  macro  hedges  to  be  segregated,  to  enable   more  accurate  monitoring  of  the  de-­‐risking  strategy  as  well  as  standalone  analysis  to   be  undertaken.   Within  a  robust  risk  framework,  reporting  principles  such  as  standardised  reporting   platform,  materiality  and  relevance  of  reports,  production  scalability  and  flexibility   along  with  infrastructure  enhancement  are  required  to  enable  efficient  risk   management  to  undertake  both  de-­‐risking  and  hedging  strategies.  This  has  become   paramount  over  recent  years  with  the  regulatory  requirements  of  both  Basel  II  and   III,  and  the  Capital  Requirement  Directive  (CRD3),  coupled  with  every  organisation   attempting  to  rebalance  their  respective  balance  sheets  by  focusing  on  their  core   businesses.  Don't  forget  either  that  the  final  CRD4  proposals,  associated  with  the   incoming  Basel  III  changes,  are  due  to  be  unveiled  in  Europe  next  year.   3  
  • 4. Senior  management  is  now  more  focused  on  analysing  the  drivers  and  diversification   affect  that  macro  hedges  have  across  the  portfolio,  on  the  basis  of  managing  the  risk   weighted  assets  (RWA)  for  capital  efficiency  effectively.  This  has  created  an   operational  strain  on  risk  infrastructures,  in  order  to  produce  and  maintain   transparent  and  accurate  reporting,  especially  for  regulatory  requirements.  This  puts   further  emphasis  on  the  need  for  an  infrastructure  that  provides  timely,  transparent   and  accurate  reporting  of  the  risk  portfolio,  to  support  de-­‐risking  decisions  in  an   effective  and  efficient  manner  by  senior  management.   The  steep  demands  of  the  CRD3  changes,  such  as  stressed  VaR  and  incremental  risk   charge  (IRC)  on  a  timely  basis  for  regulatory  reporting,  have  impacted  the  vast   majority  of  institutions.  Their  ability  to  leverage  their  current  risk  framework  is  no   longer  feasible  due  to  capacity  constraints  on  the  systems'  infrastructure.  In  turn,   this  has  dictated  the  need  for  a  greater  integration  of  risk  reporting  within  the   organisation's  hierarchy,  combined  with  the  flexibility  to  undertake  scenario  analysis   to  determine  the  diversification  impact  of  macro  hedging.   Robust  processes  and  systems  are  essential  for  accurate  and  timely  risk  reports,   combined  with  the  ability  for  increased  capacity  of  usage  at  all  levels  of  the  business.   This  requirement  has  necessitated  further  investment  in  the  current  infrastructure,   together  with  ensuring  transparency  of  the  risk  factors  being  used  in  both  VaR  and   economic  capital  calculations,  if  the  de-­‐risking  and  capital  management  strategies   are  to  be  effective.   Overall,  it  is  important  that  institutions  have  a  robust  risk  framework  in  place  to   provide  management  and  the  business  with  the  transparency  needed  to  enable   efficient  de-­‐risking  to  be  performed.  That  being  said,  the  significance  of  a  robust   systems  infrastructure  cannot  be  underestimated,  complete  with  the  appropriate   controls  and  capacity  to  facilitate  these  requirements.  Only  then  can  it  be  managed   efficiently  with  timely  and  accurate  reporting  in  place.     4