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PricewaterhouseCoopersFRM 101
1

Derrick Ryley
FX Risk -
Managing and Measuring
19 March 2002
PricewaterhouseCoopersFRM 101
2
Agenda
• Dimensions of risk that needs to be managed
• Establishing a risk control framewo...
PricewaterhouseCoopersFRM 101
3
Who Creates Risk
Agri Business
• Policy -Hedge 100% of sales
• Directors
• GM Finance
• He...
PricewaterhouseCoopersFRM 101
4
Who Creates Risk
Agri Business
• Policy -Hedge 100% of sales
• Directors
• GM Finance
• He...
PricewaterhouseCoopersFRM 101
5
Who Creates Risk
Bank
• Policy –VAR not greater than
$X million
• Directors
• GM Finance
•...
PricewaterhouseCoopersFRM 101
6
Who Creates Risk
Bank
• Policy –VAR not greater than
$X million
• Directors
• GM Finance
•...
PricewaterhouseCoopersFRM 101
7
Who Creates Risk
Gold Company
• Policy -Hedge X% of projected
production
• Directors
• GM ...
PricewaterhouseCoopersFRM 101
8
Who Creates Risk
Gold Company
• Policy -Hedge X% of projected
production
• Directors
• GM ...
PricewaterhouseCoopersFRM 101
9
Who Creates Risk
Power Company
• Policy -Hedge not less than
100% of committed sales
• Dir...
PricewaterhouseCoopersFRM 101
10
Who Creates Risk
Power Company
• Policy -Hedge not less than
100% of committed sales
• Di...
PricewaterhouseCoopersFRM 101
11
“Operational risk is the risk of
direct or indirect loss resulting from
inadequate or fai...
PricewaterhouseCoopersFRM 101
12
Common risk view
Understanding
dependencies
Information
Decisions/direction(e.g.,
control...
PricewaterhouseCoopersFRM 101
13
Ten questions to ask about your
operational risk process
• Is the full scope of operation...
PricewaterhouseCoopersFRM 101
14
Event
EffectCause
The industry is moving to a common
language for operational risk
PricewaterhouseCoopersFRM 101
15
Event
EffectCause
Sales Practices
Transaction Processing
Criminal activities
Unauthorized...
PricewaterhouseCoopersFRM 101
16
Event Effect
Cause
Impact to
Expenses
Legal
Cost/Settlement
Regulatory/
Compliance
Restit...
PricewaterhouseCoopersFRM 101
17
Event
Effect
Cause
Internal Controls
Policies & Procedures
Management Oversight
Hiring & ...
PricewaterhouseCoopersFRM 101
18
Qualitative criteria exist to advance to each step
Basic
Indicator
Approach
Standardized
...
PricewaterhouseCoopersFRM 101
19
Establishing a risk control framework
• Organisation
• Policy
• Risk Indicators
PricewaterhouseCoopersFRM 101
20
Board of
Directors
Internal Audit
Senior
Management
Operational Risk Committee
Chief Risk...
PricewaterhouseCoopersFRM 101
21
Risk Management Organizational Model
Risk Management
Approach and
Strategy
Risk Managemen...
PricewaterhouseCoopersFRM 101
22
• Provide clear guidance and communication about the
definition of risk.
• Ensure linkage...
PricewaterhouseCoopersFRM 101
23
Exposure Identification
• Transactional exposure
– Explicit exposure (event has occurred)...
PricewaterhouseCoopersFRM 101
24
Exposure Measurement
• Who is responsible?
– generally treasury
– may be coordinates
– mu...
PricewaterhouseCoopersFRM 101
25
operational risk has two dimensions of
Operational
Risk
People & Culture Business Process...
PricewaterhouseCoopersFRM 101
26
. . . Only if someone follows-up
“What gets measured gets done . . .”
Risk Indicators
PricewaterhouseCoopersFRM 101
27
Most companies have data overload yet little insight into progress toward
strategy or und...
PricewaterhouseCoopersFRM 101
28
Asset and Liability Management
Definition:
“Asset/Liability Management is the set of acti...
PricewaterhouseCoopersFRM 101
29
Reporting No FX Risk ?
Base Gap
-150
-100
-50
0
50
100
150
Jul-02Aug-02Sep-02Oct-02Nov-02...
PricewaterhouseCoopersFRM 101
30
Reporting No FX Risk ?
Pessimistic Gap
-150
-100
-50
0
50
100
Jul-02Aug-02Sep-02O
ct-02N
...
PricewaterhouseCoopersFRM 101
31
No FX Risk
Normal Sales
-40
-20
0
20
40
60
80
100
120
140
160
Jul-02
Sep-02
N
ov-02
Jan-0...
PricewaterhouseCoopersFRM 101
32
No FX Risk
Sales/Pessimistic
-60
-40
-20
0
20
40
60
80
100
120
140
160
Jul-02
Sep-02
N
ov...
PricewaterhouseCoopersFRM 101
33
Lets look at Future
Alco Gap Base
-100
-50
0
50
100
150
Jul-02Aug-02Sep-02O
ct-02N
ov-02D...
PricewaterhouseCoopersFRM 101
34
Lets look at Profit
Profit Ranges
-150
-100
-50
0
50
100
150
200
250
300
350
400
Jul-02Se...
PricewaterhouseCoopersFRM 101
35
Lets look at Profit
High/Expected/Low
-150
-100
-50
0
50
100
150
200
250
300
350
400
Jul-...
PricewaterhouseCoopersFRM 101
36
Increasing sophistication and data requirements
1. Rate Sensitive
Imbalance
(Rate Sensiti...
PricewaterhouseCoopersFRM 101
37
Conclusion
• Look at organisation as whole
• Do not limit your horizons to treasury
– The...
PricewaterhouseCoopersFRM 101
38

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FX Risk Management – Best Practice Standards for Good Corporate Governance

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FX Risk Management – Best Practice Standards for Good Corporate Governance
- by Derrick Ryley, Partner, PricewaterhouseCoopers

Published in: Economy & Finance, Business
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FX Risk Management – Best Practice Standards for Good Corporate Governance

  1. 1. PricewaterhouseCoopersFRM 101 1  Derrick Ryley FX Risk - Managing and Measuring 19 March 2002
  2. 2. PricewaterhouseCoopersFRM 101 2 Agenda • Dimensions of risk that needs to be managed • Establishing a risk control framework • Ensuring Control of FX and associated risks • Observations and final considerations
  3. 3. PricewaterhouseCoopersFRM 101 3 Who Creates Risk Agri Business • Policy -Hedge 100% of sales • Directors • GM Finance • Head trader • CFO
  4. 4. PricewaterhouseCoopersFRM 101 4 Who Creates Risk Agri Business • Policy -Hedge 100% of sales • Directors • GM Finance • Head trader • CFO
  5. 5. PricewaterhouseCoopersFRM 101 5 Who Creates Risk Bank • Policy –VAR not greater than $X million • Directors • GM Finance • Head trader • CFO
  6. 6. PricewaterhouseCoopersFRM 101 6 Who Creates Risk Bank • Policy –VAR not greater than $X million • Directors • GM Finance • Head trader • CFO
  7. 7. PricewaterhouseCoopersFRM 101 7 Who Creates Risk Gold Company • Policy -Hedge X% of projected production • Directors • GM Finance • Head trader • CFO
  8. 8. PricewaterhouseCoopersFRM 101 8 Who Creates Risk Gold Company • Policy -Hedge X% of projected production • Directors • GM Finance • Head trader • CFO • Mine Manager
  9. 9. PricewaterhouseCoopersFRM 101 9 Who Creates Risk Power Company • Policy -Hedge not less than 100% of committed sales • Directors • GM Finance • Head trader • CFO
  10. 10. PricewaterhouseCoopersFRM 101 10 Who Creates Risk Power Company • Policy -Hedge not less than 100% of committed sales • Directors • GM Finance • Head trader • CFO • Salesman/weather
  11. 11. PricewaterhouseCoopersFRM 101 11 “Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events” What is Operational Risk? There is a general consensus on what operational risk is:
  12. 12. PricewaterhouseCoopersFRM 101 12 Common risk view Understanding dependencies Information Decisions/direction(e.g., controlsorfunding) Current approaches to management are fragmented Corporate Risk Compliance Customer Service Audit Data Protection Fraud IA Testing Transaction Monitoring Physical Security IT Security A View of the Current Approach to Risk Management An Integrated, Enterprise-wide Approach to Risk Management
  13. 13. PricewaterhouseCoopersFRM 101 13 Ten questions to ask about your operational risk process • Is the full scope of operational risks being proactively analyzed? • Is there accountability for each types of operational risk? • Are issues being identified, analyzed and understood? • Are service/quality expectations being met? • How much does operational risk cost the organisation? • Is senior management rewarded for good performance? • Are risks being addressed with a suitable focus on alternatives and cost/benefits? • Is management being supportive and creating the right culture? • Are issues raised being analyzed and addressed? • Do we communicate standards to our stakeholders?
  14. 14. PricewaterhouseCoopersFRM 101 14 Event EffectCause The industry is moving to a common language for operational risk
  15. 15. PricewaterhouseCoopersFRM 101 15 Event EffectCause Sales Practices Transaction Processing Criminal activities Unauthorized activities Technology Human Resources Vendor and External Dependencies Management Process Disasters Product Event definitions are based on what happened and where
  16. 16. PricewaterhouseCoopersFRM 101 16 Event Effect Cause Impact to Expenses Legal Cost/Settlement Regulatory/ Compliance Restitution Loss of recourse Write-downs Loss of Physical Asset Any event can have multiple effects Impact to revenue/margin Service Levels Foregone Income Quality Reputation Business Interruption
  17. 17. PricewaterhouseCoopersFRM 101 17 Event Effect Cause Internal Controls Policies & Procedures Management Oversight Hiring & Training Turnover Automation Information Malice Causes indicate what controls went wrong permitting the event to occur
  18. 18. PricewaterhouseCoopersFRM 101 18 Qualitative criteria exist to advance to each step Basic Indicator Approach Standardized Approach Advanced Measurement Approach Effective Risk Management and Control Measurement and Validation None Independent op risk management Use of risk reporting Active board of directors/Senior Management Documentation of risk systems Audit review of process Risk management is conceptually sound and has integrity Sufficient resources Integration into reporting, capital, risk analysis Use in day-to-day activities Loss database and 3-5 year history 99.9% level of confidence Scaling of internal/external data Consistent process Rigorous process for including external data Capture tail risk Stress/scenario testing Disciplined over-ride process Risk reporting to support data for capital Tracking risk and loss data Mapping of event categories and business lines to standard framework
  19. 19. PricewaterhouseCoopersFRM 101 19 Establishing a risk control framework • Organisation • Policy • Risk Indicators
  20. 20. PricewaterhouseCoopersFRM 101 20 Board of Directors Internal Audit Senior Management Operational Risk Committee Chief Risk Officer Business Unit Management Business Units Operational Risk Staff Operational Risk Related Staff Functions •Compliance •Human Resources •Insurance •IT •Legal Head of Operational Risk Head Office Operational Risk Staff The management structure is characterized by a head of operational risk reporting to the Chief Risk Officer.
  21. 21. PricewaterhouseCoopersFRM 101 21 Risk Management Organizational Model Risk Management Approach and Strategy Risk Management Directives Risk Management Implementation and Monitoring Risk Identification, Assessment, Mitigation and Reporting Risk Management Program Testing Executive Management Risk Management Committee Chief Risk Officer Business Units Internal Audit Board of Directors Risk Management Philosophy The responsibility for risk management rests with the business units which will be supported by guidance from the Board of Directors and senior management. Proposed responsibilities are as follows:
  22. 22. PricewaterhouseCoopersFRM 101 22 • Provide clear guidance and communication about the definition of risk. • Ensure linkage to the company’s overall business objectives. • Reduce the possibility of miscommunication and possible errors in the management of the foreign currency program. • Define what and when. • Ensure that the company’s risk management objectives are met and that the hedging strategy is well executed. Policy
  23. 23. PricewaterhouseCoopersFRM 101 23 Exposure Identification • Transactional exposure – Explicit exposure (event has occurred) – Implicit exposure (event is scheduled/forecast to occur) • Translation or Balance Sheet exposure (FX Subsidiary) • Economic or Operating exposure (embedded in business)
  24. 24. PricewaterhouseCoopersFRM 101 24 Exposure Measurement • Who is responsible? – generally treasury – may be coordinates – must be risk committee • Data needs – large, see later slides • Timing – at least monthly or more frequent – following major change event • Tools – usual, VAR, MtM, Credit, Stress Testing, Scenario testing
  25. 25. PricewaterhouseCoopersFRM 101 25 operational risk has two dimensions of Operational Risk People & Culture Business Process Control Survey Control Environment Risk Assessment Control Activities Information & Communication Monitoring Objective, Risk & Control Alignment Define Objectives Action Planning/ Accountabilities Assess Risks Analyze Controls "Soft Controls" "Hard Controls" Risk Indicators
  26. 26. PricewaterhouseCoopersFRM 101 26 . . . Only if someone follows-up “What gets measured gets done . . .” Risk Indicators
  27. 27. PricewaterhouseCoopersFRM 101 27 Most companies have data overload yet little insight into progress toward strategy or understanding of current operational related risks . . . – Indicators are additive and not prioritised or rationalised – Use what is readily available, not what is insightful – Data is often lagging not leading – Risk indicators do not have a context - few firms have an operational risk framework and there is little to no relationship of operational risk measures to key management reporting measures or compensation – Finally, there is no proven correlation between risk and indicators - so results are discounted Risk Indicators
  28. 28. PricewaterhouseCoopersFRM 101 28 Asset and Liability Management Definition: “Asset/Liability Management is the set of actions and procedures designed to co- ordinate the organisation’s overall and individual business units contribution to its risks and financial position” Duties: 1. Devise and review strategies to maximise earnings and return on capital within agreed and measured levels of risks; 2. Monitor and discuss the status and results of agreed ALCO strategies and tactics; 3. Review outlooks affecting individual business units’ risk profile and contribution to revenue; 4. Review the current and prospective positions and monitor potential structural or market changes that can affect liquidity; 5. Review measurements reports on identified risks, including simulated exposures of risks to limits, asset mix/quality, credit, and impact of market shifts on overall organisation risk and financial position; 6. Develop parameters for pricing; 7. Provide for regular formal review of ALCO “model risk” assumptions, including an appropriate training for ALCO members, executive management and the Board of Directors.
  29. 29. PricewaterhouseCoopersFRM 101 29 Reporting No FX Risk ? Base Gap -150 -100 -50 0 50 100 150 Jul-02Aug-02Sep-02Oct-02Nov-02Dec-02Jan-03Feb-03M ar-03Apr-03M ay-03Jun-03Jul-03Aug-03Sep-03Oct-03Nov-03Dec-03Jan-04Feb-04M ar-04Apr-04M ay-04Jun-04 Sales Purchases Spot
  30. 30. PricewaterhouseCoopersFRM 101 30 Reporting No FX Risk ? Pessimistic Gap -150 -100 -50 0 50 100 Jul-02Aug-02Sep-02O ct-02N ov-02D ec-02Jan-03Feb-03M ar-03Apr-03M ay-03Jun-03Jul-03Aug-03Sep-03O ct-03N ov-03D ec-03Jan-04Feb-04M ar-04Apr-04M ay-04Jun-04 Sales Purchases Spot
  31. 31. PricewaterhouseCoopersFRM 101 31 No FX Risk Normal Sales -40 -20 0 20 40 60 80 100 120 140 160 Jul-02 Sep-02 N ov-02 Jan-03 M ar-03 M ay-03 Jul-03 Sep-03 N ov-03 Jan-04 M ar-04 M ay-04 Sales base Purchases Spot Profit
  32. 32. PricewaterhouseCoopersFRM 101 32 No FX Risk Sales/Pessimistic -60 -40 -20 0 20 40 60 80 100 120 140 160 Jul-02 Sep-02 N ov-02 Jan-03 M ar-03 M ay-03 Jul-03 Sep-03 N ov-03 Jan-04 M ar-04 M ay-04 Sales base Spot Profit Base Sales Pessimistic Profit Pessimistic
  33. 33. PricewaterhouseCoopersFRM 101 33 Lets look at Future Alco Gap Base -100 -50 0 50 100 150 Jul-02Aug-02Sep-02O ct-02N ov-02D ec-02Jan-03Feb-03M ar-03Apr-03M ay-03Jun-03Jul-03Aug-03Sep-03O ct-03N ov-03D ec-03Jan-04Feb-04M ar-04Apr-04M ay-04Jun-04 Sales Purchases Spot
  34. 34. PricewaterhouseCoopersFRM 101 34 Lets look at Profit Profit Ranges -150 -100 -50 0 50 100 150 200 250 300 350 400 Jul-02Sep-02N ov-02Jan-03M ar-03M ay-03Jul-03Sep-03N ov-03Jan-04M ar-04M ay-04 Base Base Base High Base Low Opt Base Opt High Opt Low Pess Base Pess High Pess Low
  35. 35. PricewaterhouseCoopersFRM 101 35 Lets look at Profit High/Expected/Low -150 -100 -50 0 50 100 150 200 250 300 350 400 Jul-02 Sep-02 N ov-02 Jan-03 M ar-03 M ay-03 Jul-03 Sep-03 N ov-03 Jan-04 M ar-04 M ay-04 High Base Low
  36. 36. PricewaterhouseCoopersFRM 101 36 Increasing sophistication and data requirements 1. Rate Sensitive Imbalance (Rate Sensitive Assets Less Rate Sensitive Liabilities 2. Maturity/ Repricing Gap Analysis 3. Duration Analysis 4. Simulation of Net profit and Market Value of Portfolio The ability to assess the economic impact due to changes in FX exposure has become more sophisticated over time RX Risk Management
  37. 37. PricewaterhouseCoopersFRM 101 37 Conclusion • Look at organisation as whole • Do not limit your horizons to treasury – The sales man could take you down – The banks sales man could take you down • Engage the GM’s at all level’s, the mine manager could effect you • There is no one solution, it should be within a range • Influence the upside • Cost and protect the downside • Put proper process in place • Educate • Educate
  38. 38. PricewaterhouseCoopersFRM 101 38 

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