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.

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

  1. 1. PRODUCT TAXONOMY &MODEL RISK MANAGEMENT:‘Putting the beans back into coffee’Markus Krebsz6th Annual Stress Testing Conference30 Nov - 2 Dec 2011, London
  2. 2. PRODUCT TAXONOMY ‘Putting the beans.. ..back into coffee’ 2
  3. 3. DEFINITION & STRUCTUREΤάξις = taxis (meaning order or arrangement) and νόμος = nomos (meaning law’) 3
  4. 4. WHY? Risk modeling & Stress testing Valuation & P+L explain PRODUCT Certification & Model control Risk Reporting & Management 4
  5. 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. 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. 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. 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. 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. 10. CHALLENGES 10
  11. 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. 12. CLOSEThank you very muchfor your attention, contribution and listening today!________________________________________________________________________________CONTACT:+ 44 (0) 79 85 065 12
  13. 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 / • Vista Research (Subsidiary of Standard & Poor’s) 13
  14. 14. APPENDIX: Further references 14
  15. 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: for International Settlements (BIS) Financial Stability Board. “Observations ondevelopments in risk appetite frameworks and IT infrastructure.” BIS, December 23,2010. Online:, M. “Financial securities ontology.” Hypercube Ltd., May 2007. Swaps and Derivatives Association (ISDA). “Product representation forstandardized derivatives.” White paper, April 14, 2011. 15
  16. 16. FURTHER REFERENCES (cont.)International Swaps and Derivatives Association (ISDA). “Implementation plan forunique product identifiers.” June 30, 2011.Online:, H. “Dear CEO: Valuation and product control.” Financial Services Authority,August 13, 2008. Online:, 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: Software Ltd.: www.handcoded.comEnterprise Data Management (EDM) Council’s “Semantics Repository.” Strategies—information management consultancy that specializes inapplying taxonomies, metadata and automatic 16
  17. 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 and the promotion code VA817 is entered. Thank you for your interest. 17