How regulation is changing the financial industry · How regulation is changing the financial industry Sven Ludwig Senior Vice President, Risk & Analytics EMEA ... D-SIB: 3 years

How regulation is changing the

financial industry

Sven Ludwig

Senior Vice President, Risk & Analytics EMEA

[email protected]

www.sungard.com/enterpriserisk

www.sungard.com/collateralmanagement

„LCR-xVA-FxA-xM –Puzzle“ Enough 3 letter combinations – but also for regulation?

• LCR := Liquidity Coverage Ratio

• xVA : = CVA, DVA, FVA, AVA • Credit Valuation Adjustment

• Debt Valuation Adjustment

• Funding Valuation Adjustment

• Additional Valuation Adjustment

• FxA : = FBA, FCA • Funding Benefit Adjustment

• Funding Cost Adjustment

• xM := IM, VA • Initial Margin

• Variation Margin

AGENDA

MARKET INFRASTRUCTURE, COLLATERAL & LIQUIDITY

THE NEW VALUE OF COLLATERAL MANAGEMENT (OPTIMISATION)

THE BIG RISK TYPE TRANSFER

TIKI-TAKA RISKMANAGEMENT

POLITICS & RISK

THE UNEXPECTED CONCLUSION

AGENDA

THE NEW TOP DOWN APPROACH Driver of regulation

Regulation as source of risk The international stage of politics

• Regulation is the TOP risk

• No doubt, regulation arrived on the international

stage - but of politics?

• Given the number of regulations: Is it

orchestrated classical music or …

• … hopefully like jazz and not theater

Regulation is now made top down The process of new regulations (post crisis)

G20

• G20 Summits decide on requirements for change (e.g. 2009 Pittsburgh, 2010 Seoul, …)

FSB

• The Financial Stability Board (FSB) provides recommendations

EBA,

EIOPA,BCBS

• Regulation is everywhere

• Less dialogue with industry

Implementation into national law

Changing perspectives – An outsider view Regulation of the network, not (only) supernodes

www.demonocrazy.info

Provides nice ilustration of OTC exposure

AGENDA

THE NEW VALUE OF COLLATERAL MANAGEMENT (OPTIMISATION)

THE BIG RISK TYPE TRANSFER

TIKI-TAKA RISKMANAGEMENT

POLITICS & RISK

THE UNEXPECTED CONCLUSION

AGENDA

FORCED CHANGE IN MARKET PRACTICES Liquidity & Collateral

A starting point for explanation The known future becomes “now”

Trade

date

Settlement

date

Margin

period Margin

period

Trade date 1st margining date

Historically:

Uncollateralized

Default today:

Collateralized

Trade

date

Settlement

date

Cash flow based on trade

Collateral flow

Collateral position

Impact of market movement on liquidity There is no future, it’s all now

Default today:

Collateralized

Margin

period

Settlement

date

Trade

date

Margin

period Margin

period

Next margin period date

Cash flow based on trade

Collateral flow

Collateral position

Impact of market movement on collateral Getting closer to an Interest Rate Swap, it becomes „bigger“

Margin

period

Attention:

• Sign changed!

• Multiple periods

• Focus on development of market

Cash flow based on trade

Collateral flow

Collateral position

Initial Conclusion

• Future exposure matters, it need to be

determined

• Market movements have significant impact on

collateral

• Collateral movements have an impact on

liquidity. Attention is required

Simulating the Future –

www.sungard.com/enterpriserisk EE, PFE (simple IRS Portfolio)

Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

www.sungard.com/enterpriserisk EE, PFE, CVA (simple IRS Portfolio, no CSA agreement)

Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

www.sungard.com/enterpriserisk EE, PFE a simple IRS Portfolio with CSA agreement

Screenshoot SunGard Adaptiv Analytics for high performance credit exposure analytics

• Central clearing (OTC) based on collateral.

• Collateral to meet Initial Margin (IM) and Variation

Margin (VM) needs attention.

• Collateral is a “currency”

Central clearing the silver bullet? There are nock on effects

G7 sovereigns

Sourcing of Collateral Assets Collateral has become a complex currency...

Insurance Company A

holding

government bonds

Clearing Broker Insurance Company B

Interest Rate

Swap Market

Clearing House

government bond

equity trading inventory

Collateral upgrade

Source: ZKB presentation at Swiss Finance Institute, Felix Oegerli, 15 November 2012

government bond

Bank B Bank A cash

Repo

Rep

o

cash

go

vern

men

t bo

nd

government bond

Initial Margin Initial Margin

AGENDA

THE BIG RISK TYPE TRANSFER

TIKI-TAKA RISKMANAGEMENT

POLITICS & RISK

THE UNEXPECTED CONCLUSION

AGENDA

CREATING VALUE WITH COLLATERAL OPTIMISATION

Various collateral management requirements...

Regulatory collateral requirements

Repo / liquidity arrangements

Derivatives collateral Lending program Efficient asset

allocations

Central Collateral Management & Trading Unit

Collateral Management

› Cross-product collateralization › Optimized collateral allocation › Collateral transfer pricing › Client clearing

Sec Finance / Collateral Trading

› Repo/ reverse repo › Securities lending › Collateral trading

Enterprise collateral inventory Cross-asset, real-time

Unlock Potential of Collateral Centralized Profit Center

Key steering function tightly coupled with trading, treasury, risk

Optimize the use of collateral assets

Maintain liquidity for the bank

Handle the collateralization processes across various products with high operational

efficiency

Increase trading revenues related to collateral utilization

Fund trading activities and cover shorts

Transfer price the cost of collateral

Manage risk

Collateral Optimization: The Problem

minimize

Customisable

based on: • Opportunity cost

• Funding cost

eg repo rate,

spreads

• RWA charges

• Movement costs

– additive and

multiplicative

penalties to

reflect

settlement risk

(subs)

• CSA returns

• Customisable constraints

• Incorporate linear and

non-linear constraints

• Optimised performance –

accuracy vs solving time

• Provable optimal solution

supports waterfall and

shows relative benefits

APPROACHES TO OPTIMISATION

Please visit:

www.sungard.com/collateralmanagement

Observation 1/2

• Collateral matters significantly

• Funding costs: Collateral does not come for free

• Adequate pricing and simulation is a complex task

(CVA, FVA, IM/VA Collateral demand prediction)

• Approach to collateral will change

AGENDA

TIKI-TAKA RISKMANAGEMENT

POLITICS & RISK

THE UNEXPECTED CONCLUSION

AGENDA

THE INTEGRATED RISK LOOP TRANSFER OF RISK

Regulations change of collateral & liquidity Regulations are linked

• EMIR: Central clearing of OTC derivatives

Banks will need more collateral

• Basel Paper(s): Margin requirements for non-

centrally cleared derivatives

No escape, banks will need more collateral

• Basel III: Liquidity ratios LCR and NSFR (+ ILAAP)

Banks will need high quality collateral for

liquidity buffer

Banks will need more structural term funding

BUT: You cannot get risk of risk, but transfer

24

The big transfer across types of risk Challenge: The management of the interwoven loop?

Market

Risk

Counterparty Risk

Liquidity Risk/Market

Risk

Oprisk

Credit

Risk

CAPITAL

LIQUIDITY

COLLATERAL

RWA

Credit

Risk

Market

Risk

Counter-

party

Risk

The old sequential world

(before crisis)

The new (intervowen) risk loop world

(after crisis and regulation)

AGENDA

POLITICS & RISK

THE UNEXPECTED CONCLUSION

AGENDA

BCBS239 TIKI-TAKA RISKMANAGEMENT

27

The demand for Tiki-Taka risk management? Nice, but wishful thinking?

Can “tiki-taka” tactics keep risk management on the ball?

http://www.insurancegateway.co.za/InvestmentProfessionals/Pres

sRoom/ViewPress/Irn=8540#.VGnd25gwfIV

Tiki-Taka Risk Management Nice, but impossible to achieve

• How do we achieve the integrated risk

management?

• Does the regulator help?

Why is the regulator looking at it?

Banks’ IT and data architectures were inadequate to support the broad management of financial risks.

What is BCBS239 about?

11+3 principles on: “Sound practices for risk management”

Principles for : IT architecture, Data Quality, Risk Reporting

Financial Institutions should generate accurately and reliable

risk data. The risks captured should be complete and up-to

date. Risk reports should be validated, comprehensive, clear,

useful and delivered in adequate frequency (includes ad-hoc)

to the relevant (internal) parties

29

Principles for effective risk data aggregation & reporting The regulator put integrated risk management on the spot

What is it really about – Step towards impact It seems so simple

The Principles do not

… add new concepts

… increase regulatory capital

… increase regulatory reporting

... focus on the details

… change the structure of the financial market

… request something implausible

So why do we bother?

30

31

Keep calm? The integrated loop a requirement from collateral/liquidity

31

KEEP

CALM AND

LOVE TIKI-TAKA

Example: Germany Bank’s Status Quo vs. BCBS#239

Frequency Enterprise risk report:

Today often quarterly Monthly

Time lag between data and delivery of risk report:

Today T+7 to T+56 T+10

Risk report via “push a button”

Risk Manager calculates and comments (differences in stored results and comments) risk values are provided, comments in DWH

Automated interim layer

Excel/Access for Aggregation & Processing Risk Data are provided and not calculated by risk manager

Focus of Risk Manager

Today’s job about data collection and QS Majority of time spend: Analysis

32

(Source: DEUTSCHE BUNDESBANK)

The aggregation challenges and approaches Strategic infrastructures: Its about a concerted approach

33

+ +

≠

High quality data IT Architecture Risk Reports

Profitable steering

of the financial insitution

Kitchen with

cooking tools Ingrediends

for meal (spaghetti

Pomodoro=

Michelin stared

meal

Cooking book

What is it about – Step towards impact How wisdom can be gleaned from information

The Principles do: … request the obvious

… require data quality

… require data accuracy and integrity

… require timliness

… require adaptability (ad-hoc, crisis, internal & reg. changes)

... require a reconciled risk production process

… address the key pain points nobody wanted to address earlier

… address the needs of the executive board

The Impact: … do change risk management in its foundation

… it is a game changer for banks (& other financial institutions)

... it is a game changer for a financial institutions IT

34

Some facts on BCBS 239 Rolling down from Tier 1 & spill over from the group

Timeline:

G-SIFIs (G-SIBs & SII): The principals have to be implemented completely by 1st of Jan 2016

D-SIB: 3 years after their designation as D-SIB

Regulator already now expects actions and efforts to fulfill the principals

Impact if regulation is not fulfilled

Regulator can set risk limits or limit growth

For G-SFIS only?

No, D-SIB as well … and group wide …

All financial institutions dependent on discretion / judgment of national regulator

35

The challenges and approaches It is a program, not project

Common building blocks the approaches

1) Data quality framework

2) Risk reporting (practices & capabilities)

3) IT architecture

36

BCBS239 the ultimate regulation? It is a $1.5bn p.a. investment of the industry

37

$-

$500.000.000

$1.000.000.000

$1.500.000.000

$2.000.000.000

$2.500.000.000

2014 2015 2016 2017 2018 2019

BCBS#239 linked investments

SII andotherD-SIBs

G-SIBs

Source: SunGard

The BCBS239 Message

CEOs understood the broader context

CEOs expect that the principles extend to other areas

It is about steering the institution more accurate

It is about the integration of Risk, Finance, regulatory

reporting and provide business access to the

combined world.

The interwoven risk management, not just via market

infrastructure regulation.

38

AGENDA

THE UNEXPECTED CONCLUSION

AGENDA

Politics and regulation THE HIDDEN TOOLS

What’s about capital?

The entire pillar one is worked. Focus on the fairly

final one:

• BCBS279: The standardized approach for

measuring counterparty credit risk exposures („SA-

CCR“)

Improves the risk sensitivity of the capital framework without creating undue complexity

Suitable for wide variety of transactions (unmargined, margined, bilateral cleared, centrally cleared)

More reflective of legal and economic offsetting

Implementable simply and easily

Regulatory bodies: Less room for discretion

41

What does SA-CCR aim at? Address the known deficiencies of the CEM and the SM

42

TRANSACTION(S) CEM

(% OF NOTIONAL)

SA-CCR (% OF NOTIONAL)

DETAILS OF SA-CCR CALCULATION SA-CCR

/ CEM

01 5-year Interest Rate

Swap – Unmargined 0.5% 3.1%

0.5% Add-On x 1 Maturity Factor x 4.4

Supervisory Duration x 1.4 Alpha 620%

02 5-year IRS – Margined 0.5% 0.93% 0.5% Add-On x 0.3 MF x 4.4 SD x 1.4 Alpha 186%

03 3-month FX Forward –

Unmargined 1% 2.8% 4% Add-on x 0.5 MF x 1.4 Alpha 280%

04 6-month Equity Option

(50% Delta, MtM 2%)

8% (2%MtM + 6%

Add-on)

18.66% (2% MtM + 32% Add-on x 0.71 MF x 0.5 Delta)

x 1.4 Alpha 233%

05 1-year Equity Forward 6% 44.8% 32% Add-on x 1 MF x 1.4 Alpha 747%

06 Two completely

offsetting 5Y IR Swaps

0.2% (0.5% x 40% due

to zero NGR)

0% Transactions are long/short in same hedging

set hence completely net Add-ons 0%

07 Two opposite 6M FX

Options (Buy & Sell the

same Option)

0.4% (1% x 40% due

to zero NGR)

0% Transactions are long/short in same hedging

set hence completely net Add-ons 0%

08 Two 6M FX Forwards

(USD/EUR + GBP/USD)

with opposite MtMs

0.4% (1% x 40% due

to zero NGR)

3.96%

4% Add-on x 0.71 MF x 1.4 Alpha

Transactions are in different hedging sets (based

on currency pairs) and hence add-ons don’t offset 990%

The impact of SA-CCR vs. CEM The reality: A push towards central clearing

Pre-Final conclusion

Does is work together?

EMIR

Principles for effective Risk Data aggregation and

reporting

Basel III (Liquidity Ratios)

Rework of Pillar I: SA-CCR

Regulation is an orchestrated approach

Where are the politics?

43

How politics enter the game – Stress Test Result The tools of local accounting

AGENDA AGENDA

Unexpected? THE CONCLUSION

8,0

5,5

8,0

6,0

4,5 4,0

2,5

Max

2,5

Max

8,5

8,0

6,0

4,5

8,0

6,0

4,5

Max

5,0

Max

5,0

Max

7,5

1,875

Max

2,5

8,0

4,0

2

2019 2018 … 2015 2014 2013

Core Tier I capital

Core Capital

Total Capital

Countercyclical Buffer

Capital Conservation Buffer

Systemic Risk Buffer

8%

13,5%

Basel III capital buffer(s): Focus on core tier-1 capital

The (non-) level playing field in Europe

Source: Prof. Hermann Schulte Mattler

Final conclusion

Steering Core-Tier-1 Capital is the focus

After adoption of the changes, risk bearing capacity

becomes a secondary constraint

Not regulation is the top risk, its politics

The country focus vs. Europe

47

THANK YOU

Dr. Sven Ludwig

Senior Vice President, Risk & Analytics EMEA

[email protected]

+49-176-1111-0174

Please visit:

www.sungard.com/enterpriserisk

www.sungard.com/collateralmanagement