TASCORP: RISK MAPPING                                     Pascal vander Straeten 2012Pascal vander Straeten – JULY 2012   ...
• Copyright © 2012 by Pascal vander Straeten• All rights reserved. No part of this publication may be  reproduced, distrib...
Contents• Section I: TASCORP risk mapping• Section II: Objectives & action plan                                         Pa...
Section ITASCORP risk mapping                       Pascal vander Straeten 2012                              4
Risk mapping Findings credit risk: • ‘Bond’ implied rating of State of Tasmania: ‘Aa2’ vs. ‘Aaa’ (3 months ago the ‘bond’ ...
Risk mapping Findings market risk • Objective is to minimise P&L volatility and preserve value – stabilise TASCORP earning...
Risk mapping Findings liquidity risk •   TASCORP has high % readily available assets for sale and > annual LT & ST maturit...
Risk mappingFindings funding risk• Declining volume of customers deposits (mix deposits/ borrowings : 17/83 in 2011 down f...
Capital management    Findings capital allocation:    Tascorp’s capital base ($42 mios) is allocated as follows (cf. since...
Upcoming significant regulatory & accounting guidelines for TASCORP    Findings on upcoming APRA (APS):    • Basel 2.5 on ...
Section IIObjectives & action plan                           Pascal vander Straeten 2012                           11
‘Ultimate/ core’ objectives• Dynamic management of capital allocation through daily monitoring fed  by amongst others dail...
1.       Guidelines & process                           •    ‘Basel 3’ background - Review road map for Risk Management an...
Action plan30 Days1    Meet internal stakeholders and mapping ‘output/ reporting’ needs.2    Gap analysis on policies & pr...
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Tascorp risk mapping

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  • Investment portfolio:Volatility in volume financial assets $6.8 bios (2009) - $5.3 bios (2010) - $7.1 bios (2011) due to volatility in volume investment ptf (respectively $3.7 bios; $2.4 bios; and $4.1 bios) as approx. 70% are ST investments
  • Due to volatility in volumes of ST investment portfolio, volatility in VaR (Historic - 99% daily) is at $770,000 (highest in 2011) vs $568,00 (2010) and $1,299,000 in 2009.Choice of historical approach for VaRGeneral interest rate risk – previously parametricSpecific interest rate risk – historical approachNow, for all types of interest rate risk use of historical approach => Gives more consistency and precise measureStandard in all banksFacilitates stress testing, the analysis of extreme values, …Non-linear risk factors will be revaluatedIn addition also P&L triggers, nominal limits, maturity limits, limits on authorised products, market limitsVaR in normal market conditions, while stress-testing measures market risk in abnormal conditionsOnly trading portfolio is subject to VaR, while banking book has different investment horizonMarket risk - Stress testingIf using internal models to meet market risk capital requirements then rigorous stress testing programShould include low probability events related to both market risk, credit risk, and operational riskSet of quantitative and qualitative stress testsCombine supervisory stress scenarios plus in-house stress scenariosSupervisory stress scenarios could be effects related tp 1998 Russian financial crisis, 2000 internet bubble, 2007/2008 subprime bubbleValidation of structure of internal model adequate with respect to bank’s activities and geographical coverageData flows and associated processes are transparent and accessible.Back-testing whereby actual Trade P&L results compared with model-generated risk measures, counting the number of times that the trading losses were larger than the risk measures, and if confidence interval is 99% then model must really cover 99% of times of real trade lossesGreen zone: max 4 exceptions for 250 observations; yellow zone: 5-9 exceptions (and this would cause an increase in the multiplication factor); red zone with more than 10 exceptionsAssessment integrity VaR model based on (i) end-to-end processing of position to get to VaR output; (ii) VaR internal model (+ back-testing).“Back-of-the-envelope” calculation for Market Risk Capital estimates, i.e. => MRC = {k x [VaR + Stress VaR]} + {IRC or CR or SRC} where‘k’ is at least ‘3’ and max ‘4’ (cf APRA)(and VaR is highest of ‘VaR t-1’ (= yesterday) and ‘average’ VaR last 60 business days)(and Stressed VaR – idem)(k = multiplication of at least ‘3’ and max ‘4’); the max ‘4’ will depend of ex-post performance of the model (backtest only the VaR)
  • RWA requirementsCounterparty credit exposure calculationsCVA: add-on capital charge to cover unexpected MtM unexpected counterparty risk/ CVA lossesWrong-way risk (f. ex typical with monoliners)For trading activities:Stressed VaRA new incremental risk charge (IRC) for credit trading book positions taking into account liquidity risk, widening of spreads, default risk, and credit migration risk
  • => TASCORP refinances on LT but is then exposed to basis risk (changes in relative pricing along the yield curve) => there is a direct cost to this that cannot be directly recovered from clients, and hence transferred to the State.Thus debt policies must be in line with not only risk appetite of Government Business but also with risk appetite of the State => thus approach is a whole-of-government approach focusing on lengthening the State’s debt maturity profile.While Lt debt is more costly, on the other hand future funding costs are more predictable and reduces refi risk (funding difficulties). The additional cost of longer-term debt is effectively and insurance premium.
  • Tascorp risk mapping

    1. 1. TASCORP: RISK MAPPING Pascal vander Straeten 2012Pascal vander Straeten – JULY 2012 1
    2. 2. • Copyright © 2012 by Pascal vander Straeten• All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission Pascal vander Straeten 2012 of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, write to the publisher, addressed “Attention: Permissions Coordinator,” at the address below. • 4/49 Hampton Circuit, Yarralumla, 2600 ACT; Email: pascalnewyork@hotmail.com 2
    3. 3. Contents• Section I: TASCORP risk mapping• Section II: Objectives & action plan Pascal vander Straeten 2012 3
    4. 4. Section ITASCORP risk mapping Pascal vander Straeten 2012 4
    5. 5. Risk mapping Findings credit risk: • ‘Bond’ implied rating of State of Tasmania: ‘Aa2’ vs. ‘Aaa’ (3 months ago the ‘bond’ implied rating was ‘Aa3’). • Investment portfolio: • Strong growth portfolio investment (from $2.4 bios in 2010 to $4.1 bios in 2011), and high quality counterparties => Rating mix: All Cpies > A- (LT) and > A-2 (ST). • Due to fair value accounting and change in risk profiles, volatility in credit margin gains/ losses on investment portfolio ($1.3 mios in 2011, $45.5 mios in 2010) causing volatility shareholder’s equity. • Client advances portfolio (cf volume remain stable at around $3.0 bios): • As a result of core business/ mission of TASCORP => high concentration: top 4 client advances = 93% total client advances and close to 40% of total financial assets. • Due to fair value and change in risk profiles, volatility in credit margin gains/ losses on client advances ($-16 mios in 2011, $32 mios in 2010) creates volatility in equity. Pascal vander Straeten 2012Impact credit risk for TASCORP: • Close monitoring of largest client advance’ exposures such as Hydro Tasmania & Aurora Energy => State Guarantee, but importance stand-alone rating (Aurora Energy) (cf. the idea being not to rely on State Guarantee) • On stand-alone basis: Aurora has ‘BBB’ range rating, Hydro Tasmania also ‘BBB’ range, and Transend ‘A’ rating range. But 2011 results are overall better than previously so quality of SOEB has relatively improved. • Basel 3 and TAS Debt Maturity Profile policy will drive risk appetite in relation to client advances and investment portfolio. • For instance TASCORP could less focus on committed liquidity facilities as undrawn or contingent facilities currently weigh heavily/ negatively in terms of Basel 3. • Bearing in mind the TAS Debt Maturity Profile policy, TASCORP should try to re-direct client advances towards 5-10 years lending facilities. 5 • Concurrently reduction of ST borrowings (CP) during 2012 and volume reduction of the investment portfolio would in turn potentially result in less volatility in credit margins gains/ losses, and ultimately lesser impact on shareholder’s equity.
    6. 6. Risk mapping Findings market risk • Objective is to minimise P&L volatility and preserve value – stabilise TASCORP earnings • Market value hedge: irrespective of clients’ preferences, TASCORP continue to fund itself on LT • Interest rate risk captured through: • Market value sensitivity (VaR 97.5% - 10 days impact on shareholder’s equity) • Net interest earning at risk with 100 bps parallel shift yield curve and ALM simulation (monthly) • Stressed VaR: • 10-day horizon, 99% confidence interval, type of approach is free of choice (historical, parametric, and Monte Carlo); Absolute volatilities rather than relative volatilities • At least 12 month period relating to significant losses to be a period of such stress • Weekly calculation and monthly update of historical date based on triggers such as change in trading portfolio volume, or if VaR exceeds Stressed VaR. Pascal vander Straeten 2012Impact market risk on TASCORP: • Stressed VaR - deadline January 2013 • “Back-of-the-envelope” calculation for Market Risk Capital estimates, i.e. => MRC = {k x [VaR + Stress VaR]} + {IRC or CR or SRC} where ‘k’ is at least ‘3’ and max ‘4’ (cf APRA) • Time consuming issue on choice of 12 month historical stress period as data during 2008 crisis are of poor quality. VaR will need to be run on longer periods as time goes by. • Divide risk factors into liquid and illiquid ones • Liquidity risk managed by VaR (with low/ high volatility trader can have high/ low positions) • Illiquidity managed by market sensitivity (and max sensitivity to cap risk for extreme movement) • For linear portfolios sVaR is natural extension of VaR and will add no value for risk management. • Monitor sVaR at inception making sure that VaR at future stress periods can still be managed 6 effectively by traders. => Assumption (!) : Stressed VaR is usually equal to roughly 2.5x VaR under ‘normal’ market conditions but can vary greatly amongst institutions. TASCORP had VaR equal to $770,000 (highest in 2011). So Market Risk Capital estimate could potentially be equal to roughly $8-10 mios {=(VaR + 2.5VaR)x4}.
    7. 7. Risk mapping Findings liquidity risk • TASCORP has high % readily available assets for sale and > annual LT & ST maturities, plus strong internally generated cash flows • Basel 3: ‘Liquidity coverage’ ratio: maintain enough liquid assets for 30 days under stress scenario specified by supervisor • Basel 3: ‘Net stable funding’ ratio: maintain stable sources of funding relative to illiquid assets and off- balance sheet contingent calls over 1-year horizonImpact Basel 3 on liquidity & funding strategies for TASCORP: • Reduce business with unfavourable liquidity treatment – for instance reduce committed and liquidity facilities – impact on client advances (cf. $205 mios committed not yet settled per 2011). • Raise liquidity of investments (HQLA1 and HQLA2: government debt and min ‘AA-’ corporate Pascal vander Straeten 2012 bonds (non-bank issuers) and covered bonds) – but lower yielding bonds will hurt profitability. • But problem for Australia, relatively low supply of HQLA1 & HQLA2, thus instead committed secured liquidity facility to cover shortfall (eligible securities are RMBS, CMBA, credit card ABS, ABCP) … LCR not applicable to small ADIs (which will continue to be regulated under the minimum liquid holdings regime) • Good news for the Australian asset-backed securities market and covered bonds. • TASCORP may have hard time finding liquid assets since all financial institutions may be trying to find them at the same time and face a market movement against them. • Raise retail deposits – quid State of Tasmania & local authorities + SOEB. • Reciprocity: in exchange for taking SOEB debt on books, TASCORP could pool cash of these same SOEB and hence have a higher share of deposits; beneficial for Basel 3. • Raise additional LT funding debt & capital: Ok through preferred stock • Reduce wholesale credit – impact on external funding (reduce commercial paper) 7 • Adjust pricing compensating higher funding cost: lending margin increased from 0.50% to 0.75%. • Significant burden in terms of internal processes & resources (f ex modeling cash flows, monitoring funding concentrations, running wide range of stress tests with various scenarios).
    8. 8. Risk mappingFindings funding risk• Declining volume of customers deposits (mix deposits/ borrowings : 17/83 in 2011 down from 31/69 in 2009 as well as 2010)• Increasing volume of CP (from $700 mios to $3.5 bios), and particularly overseas ($1.6 bio)• Matching duration of borrowing clients’ loans• Total funding $5.8 bios, of which: • 2012: $3.4 bios • 2013: $800 mios • 2014: $750 mios • 2015: $550 mios • 2020: $100 mios Pascal vander Straeten 2012Impact funding risk for TASCORP:‘Refi’ risk mostly in 2012-2014 addressed through issuance of Preferred Stock. But volume ofexpected issuance for 2012-2014 is enormous (more than 6x the last issuance done), hence:- Causing a concern for insufficient market appetite for big issue tickets, and TAS is not only semi- govt to have refi needs in 2012. But Basel III provides a welcoming support for semi-govt bonds.- Euro-zone crisis might spread to China (& SE Asia) and hence spill-over to Australia (& Tasmania) causing a more ‘expensive’ cost of refinancing.Focus on longer dated funding important & avoiding large refinancing risk- Reduction investment portfolio hence reducing need for ST borrowings- Maintaining liquidity through large and liquid benchmark bond lines- Ensuring global investor participation 8- Benchmark bond issuance pricing transparency- Diversity of funding (Quid inflation linked issuance, Issuance in non-AUD market)
    9. 9. Capital management Findings capital allocation: Tascorp’s capital base ($42 mios) is allocated as follows (cf. since 2010 $10 mios was added to the capital base): • Approx. 5% to operational risk (data event collection, self assessment). • Approx. 40% to credit default risk (through PD, LGD, EL and under Basel 3 the EAD will be calculated with the Effective Expected Exposure (EPE) for trading exposures). • Approx. 55% to market risk, of which • Approx. 35% to credit margin gain/ loss evolutions (changes in fair values due to change in credit risk profile) • Approx. 5% to interest rate risk (through VaR - single number of a bank’s estimate of loss) • Approx. 5% to liability margin gain/ loss evolutions (changes in fair values due to change in credit risk profile) • Approx. 10% to generic semi-govt v. TASCORP risk (through gap between base rate charged to clients (generic semi-govt curve and TASCORP curve)) => New ratios in ‘Basel 3’: • Pascal vander Straeten 2012 Tier 1 Leverage ratio from 0% to 3% • Tier 1 Common from 2-3% to 7% • Conservation Buffer of 2.5% • Minimum Tier 1 Capital ratio from 4-6% to 8.5% of RWA • Total Capital ratio from 8-10% to 10.5% • PLUS : Countercyclical capital buffer from 0% to 2.5%Impact capital allocation for TASCORP:• Manage risk exposures ‘dynamically’ taking also into capital allocation and liquidity constraint.• Due to leverage ratio constraints TASCORP will either have to gradually increase shareholder’s equity and/ or reduce total assets (ie. investment portfolio). Concern is that if TASCORP reduces solely investment portfolio, it will undoubtedly hurt the Basel 3 liquidity ratios => Catch 21 !• Stressed VaR will eat away big chunk of capital base unless investment portfolio is reduced, but here again the latter would subsequently hurt Basel liquidity 3 ratios. Quid different accounting treatment? 9
    10. 10. Upcoming significant regulatory & accounting guidelines for TASCORP Findings on upcoming APRA (APS): • Basel 2.5 on market risk framework • Basel 3.0 on liquidity and capital ratios (APS 330) – 2013-2018 Upcoming accounting standards: • AASB 7 (IFRS 7): financial instruments disclosures • AASB 9 (IFRS 9): financial instruments classification • IFRS 13: fair value measurementImpact Basel 2.5 and 3.0 on TASCORP: Pascal vander Straeten 2012• Stressed VaR – cf supra• Leverage ratio: assume $41.4 mios total equity against $7.1 bios total assets, being equal to 0.5% (vs min. 3% required) – parallel running already in 2013, disclosures in 2015, and Pillar I in 2018.• Absence specific info on RWA of TASCORP, but RWA ‘rough’ estimate might be around $150 million considering nature of risk exposures on books (highly rated (AAA/ AA) and more than 50% being ST investments). Hence compliance with ‘NEW’ Tier 1 and capital ratios should be OK.Impact future accounting changes on TASCORP:• AASB 7 (IFRS 7): no material impact on disclosures• AASB 9 (IFRS 9): Financial Instruments January 2013: either amortised cost or fair value; but exposure draft on ‘hedge accounting’ expected by 3Q 2012.• AASB 9 (IFRS 9): Impairment: assessment only on assets under amortised costs (and use of cash flow model). Roughly 5% of financial assets under amortised cost and thus 95% under fair value. For AFS (assets under fair value) test consist to track decline in fair value (>20% vs. original cost) 10• IFRS 13: Fair value treatment will only bring about additional disclosures.
    11. 11. Section IIObjectives & action plan Pascal vander Straeten 2012 11
    12. 12. ‘Ultimate/ core’ objectives• Dynamic management of capital allocation through daily monitoring fed by amongst others daily calculation of (stressed) VaR and daily assessment of impact credit margin volatility on shareholder’s equity.• Re-adjust lending & investment policy to new Basel III liquidity and capital requirements.• Help maintain accessibility to capital markets by maintaining float in the market.• SOEB – keep TAS control on overall debt load & debt maturity profile Pascal vander Straeten 2012 through TASCORP (cf new government business borrowings should be between 5-10 years).• Shield TAS from refi risk in relation to upcoming maturities.• Asset quality: keep absence doubtful assets and no reliance on TAS guarantee.• Help TAS forecast future cost of funding (daily monitoring gap between Semi govt bond and TASCORP funding cost; management TAS debt maturity profile, etc).• Help bring TAS rating to twin ‘AAA/ Aaa’ by 2015• Keep best market practices in relation to risk management and be 12 expertise center in TAS.
    13. 13. 1. Guidelines & process • ‘Basel 3’ background - Review road map for Risk Management and setting objectives with proposed action plan. • Gap analysis on policies & procedures, review governance Risk Management (AS/NZS Standard) • Annual risk mapping exercise + action plans to address potential gaps – to be submitted to Board. • Inventory of all risk reports produced, and matching between needs and changing regulatory requirements • Synergies between market risk and credit risk indicators; early warning system, mutualisation of data resources. • File management and proper inventory & follow-up of collateral/ securities/ tangibles. 2. Market risk • Build dash board market risk indicators inclusive of (stressed) VaR, P&L triggers, maturity limits, etc • Stress scenarios: include also TAS Downgrade scenario amongst set of scenarios to buildActions - proposals 3. Capital allocation • Build capital management dash board inclusive of simulations around impact Basel 2.5 and 3.0. Indicators should regroup in relation to (stressed) VaR, change in credit margin gains/ losses, operating risk, credit default risk, etc. Pascal vander Straeten 2012 4. Credit risk & capital allocation • Basel 3: impact leverage ratio on business model • Basel 3 + TAS Debt Maturity Profile policy: align risk appetite between Government Business-TASCORP-TAS. • Determining loss mitigation techniques and flagging sensitive assets – monthly update. • OTC derivatives – use of central clearing counterparties (LCH/ Swapclear) as well as use of Trioptima. • Early Warning System with MtM prices, maturity, RWA, rating, exposures, liquidity, cost of carry, and sensitivity. • Review credit risk measurement – imputation of exposures (haircut, add-on, inclusion of collateral posting). • Review of ISDA/ CSA contracts & covenants, and challenging of collateral posting. 5. Liquidity & funding risk • Basel 3: Simulations on impact NSFR and LCR in relation to current investment & lending policy. • Basel 3: Looking with FM and Finance at contingency liquidity and funding plan. 13 • ALM/ BSM: Optimise use of investment assets on balance sheet - repo, swap of bonds, secured lending. 5. Operational risk and Business Continuity Plan; build loss event database.
    14. 14. Action plan30 Days1 Meet internal stakeholders and mapping ‘output/ reporting’ needs.2 Gap analysis on policies & procedures, in particular follow-up Capital & Market Risk Policy.3 Focus on (stressed) VaR and capital management & allocation policy4 Review ISDA/ CSA agreements with financial institutions.5 Maintain going concern – avoid interruption on reporting duties. Pascal vander Straeten 20126 Build rapport with Board of Directors and Audit Committee.7 Mutualisation of data/resources between credit and market risk.60 Days1 Align risk appetite between TASCORP/ SOEB/ and TAS on investment & lending policy in light of Basel 3 and Debt Maturity Profile policy.2 Working group on accounting treatment of investment positions3 Mapping of risks in relation to credit, market, operational, and liquidity.4 Work with FM and Finance on building stress tests and scenarios in relation to LCR, NSFR, and capital ratios (including leverage ratio).5 Alignment w/ Internal Audit findings & recommendations on RM. 146 Review of credit risk measurement tool.

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