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Transcript of 1 Enterprise Risk Management April26-27 Chicago, Illinois Chief Risk Officer Forum Dr. Robert M....
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Enterprise Risk ManagementApril26-27
Chicago, Illinois
Chief Risk Officer Forum
Dr. Robert M. MarkDr. Robert M. MarkCEOBlack Diamond Tel: 925 878 [email protected]
Black Diamond Risk Management 2
Dr. Robert M. MarkDr. Robert M. [email protected] 925 878 9943
l Dr. Robert M. Mark is the Chief Executive Officer of Black Diamond which provides corporate governance, risk management consulting and transaction services. He serves on several Boards such as the Fields Institute for Research in Mathematical Sciences, IBM’s Deep Computing Institute, Checkpoint Canada, The Royal Conservatory and is an Advisory Director on Entergy Koch’s Audit Committee of the Board . He also serves on Checkpoint’s Investment Committee. In 1998, he was awarded the Financial Risk Manager of the Year by the Global Association of Risk Professionals (GARP). He is the Chairperson of The Professional Risk Managers’ International Association’s (PRMIA) Blue Ribbon Panel
l Prior to his current position, he was the Senior Executive Vice-President and Chief Risk Officer (CRO) at the Canadian Imperial Bank of Commerce (CIBC). Dr. Mark was a member of the Management Committee. Dr. Mark’s global responsibility covered all credit, market and operating risks for all of CIBC as well as for its subsidiaries. Prior to his CRO position, he was the Corporate Treasurer at CIBC.
l Prior to CIBC, he was the partner in charge of the Financial Risk Management Consulting practice at Coopers & Lybrand(C&L). The Risk Management Practice and C&L advised clients on risk management issues and was directed toward financial institutions and multi-national corporations. This specialty area also coordinated the delivery of the firm’s accounting, tax, control, and litigation services to provide clients with integrated and comprehensive risk management solutions and opportunities.
l Prior to his position at C&L, he was a managing director in the Asia, Europe, and Capital Markets Group (AECM) at Chemical Bank. His responsibilities within AECM encompassed risk management, asset/liability management, research (quantitative analysis), strategic planning and analytical systems. He served on the Senior Credit Committee of the Bank. Before he joined Chemical Bank, he was a senior officer at Marine Midland Bank/Hong KongShanghaiBank (HKSB) where he headed the technical analysis trading group within the Capital Markets Sector.
l He earned his Ph.D., with a dissertation in options pricing, from New York University’s Graduate School of Engineering and Science, graduating first in his class. Subsequently, he received an Advanced Professional Certificate (APC) in accounting from NYU’s Stern Graduate School of Business, and is a graduate of the Harvard Business School Advanced Management Program. He is an Adjunct Professor and co-author of “Risk Management” (McGraw-Hill), published in October 2000. He also served on the board of ISDA as well as the Chairperson of the National Asset/Liability Management Association (NALMA).
Black Diamond Risk Management 3
A significant challenge for a CRO is to stay on top of a complex combination of factors which drive risk
CustomersInvestors
MarketsRegulatorsRating AgenciesEquity Analysts
PeopleCulture
IncentivesExperience
PeopleCulture
IncentivesExperience
Cre
dit R
isk
Market R
isk
Operations Risk
lThe ability to efficiently integrate all the components of risk as well as to effectively operate in markets while serving customers as well as satisfying regulatory requirements is a direct function of the quality of the people, the associated culture, as well as incentives and experience
Black Diamond Risk Management 4
POLICIES METHODOLOGIES
INFRASTRUCTURE
A significant challenge for a CRO is to build a proactive risk management function that can be benchmarked in terms of:
Black Diamond Risk Management 5
l The CPMG has become part of the landscape through which proactive risk management functions are actively managing their Credit Portfolio
POLICIES METHODOLOGIES
INFRASTRUCTURE
For example, a proactive risk management function would include building a Credit Portfolio Management Group (CPMG)
ProactiveRisk
Management
Black Diamond Risk Management 6
l Ongoing Policy Assessment from a CRO’s perspective involves asking several critical questions. These include:
l Is the tolerance for risk consistent with the Business Strategies?
l Do the risk authorities reflect a desired tolerance for risk?
l Is risk properly disclosed internally and externally?
Dis
clos
ure
Au
tho
rities
Risk
Tolerance
BusinessStrategies
IndependentFirst-Class
Proactive RiskManagement
Policies
Black Diamond Risk Management 7
l A Significant challenge for a CRO is to ensure that there is a formalized process to discuss and debate the tradeoffs amongst the various business units to opportunistically increase their risk.
l The tolerance for risk is ideally tied to a well articulated and transparent business model.
Strategy and Risk Tolerance
Dis
clos
ure
Au
tho
rities
Risk
ToleranceBusinessStrategies
IndependentFirst-Class
Proactive RiskManagement
Black Diamond Risk Management 8
Example 1: August 1998:
Equity prices dropped sharply
Equity Volatility increased
Liquidity dried up (Flight to quality)
Correlations broke down
Credit spreads widened
Credit quality deteriorated
WideCreditSpread
HighVolatility
LowLiquidity
August ‘98
Black Diamond Risk Management 9
Risk Authorities58mm
29mm
July 22
Oct 02
Nov97
Mar98
Jul98
Aug98
Oct98
Feb99
Jun99
Jul99
Aug99
Sep99
Oct99
A key challenge for CRO’s during Aug 1998 was to adjust the tolerance for risk in advance of extreme negative markets. For example:
VaR
38mm
Black Diamond Risk Management 10
l A test of best practice risk management is an organization’s ability to provide disclosure which makes the risk transparent to managers.
l Analytically rich disclosure is critical to a strong risk management process.
l Risks and financial flows should be well understood by managers and other stakeholders.
Dis
clos
ure
Au
tho
ribties
Risk
Tolerance
BusinessStrategies
IndependentFirst-Class
Proactive RiskManagement
Risk Disclosure
Black Diamond Risk Management 11
Certain types of disclosure have now become standard
Example 2: Daily Net Trading Revenue vs. Value at RiskC
$ M
illi
ons
ALCO Limit - Upper Boundary
ALCO Limit - Lower Boundary
Potential Predicted Positive Revenue
Daily Net Trading Revenue
Potential Negative RevenuePredicted
Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct
August 27, 1998 August 27, 1998
Black Diamond Risk Management 12
l Ongoing assessment of methodologies involves such questions as:
l Is the design and implementation of VaR as well as stress testing methodologies appropriate?
l Are the mathematical models properly vetted?
l Are the positions properly valued?
l Are the risk methodologies tied into performance measurement?
IndependentFirst-Class
Proactive RiskManagement
Performance
Vetting Stress
Testing
VaR
There are many significant methodological challenges for a CRO
Black Diamond Risk Management 13
Positions Scenarios
TradingRulesInitial
PositionData
Change inPositionsHedging
DynamicAdjustments of
The Greeks
Positions Adjust
Over Time
P & L
Results
MarketMovementsOver Time
Horizon
ScenariosData
Volatility
Price PathImpact onLiquidity
}
Example 3: A key market risk challenge for a CRO is to realistically capture liquidity risk
Black Diamond Risk Management 14
l Ex: Credit Limit exposure for derivatives is typically measured through using a single Worst Case (W) or 2/3 W exposure and then combine it with credit risk limits in the banking book against the same obligor
Worst Case” Credit Worst Case Terminal Exposure (WT)
Cumulative Average Worst Case
(FE = 2/3 WT)
Expected Terminal ExposureIf W set at a 2 sigma = WT /5
Cumulative Average Expected Exposure
(=2/3 x WT /5)
Best Case (0) Time (T)
“Exposure path
“Expected” CreditExposure path
0 T
Example 4: A credit risk challenge for a CRO is to appropriately characterize credit risk in the trading book and integrate it with credit risk in the banking book
Black Diamond Risk Management 15
l Stressing the boundaries of credit risk
Credit risk factors may be shocked . . .
. . .To produce perturbations of combined distributions of
simulated future credit lossesEXPOSURE
DEFAULTS
RECOVERIESt 0
tN
0
TIMECREDIT LOSS
PR
OB
AB
ILIT
Y
Shocks
Correlations to other factors
Example 5: A key challenge for a CRO is to arrive at realistic reasonable paranoia stress tests?
EXAMPLE
Black Diamond Risk Management 16
Example 6: A key challenge for the CRO is to price market, credit and operational risk. For example, the credit risk for a Credit Derivative can be modeled as a put (utilizing a Merton Style “structural form” model)
l
l where P is the current value of the put, N(.) is the cumulative standard normal distribution, and
l and is the standard deviation of the rate of return of the firm’s assets.
)()( 201 dNFeVdNP rt -+--= -
TS
TFeV
TS
TrFVd
rT 22
10
22
10
1
)/ln()()/ln( ss +=
++=
-
Tdd s-=12
Black Diamond Risk Management 17
…and can be used to calculate expected credit spreads (CS). Liquidity is a key element that is difficult to incorporate
l Yield to maturity and credit spreads can be calculated according to well known technology:
l
[ -+-=-= - )]()(ln1
10
2 dNFe
VdN
Try rTTTcs
TF
PFe
TFB
y
rT
T
-
=-=
-
lnln 0
TrryTT -=cs
Black Diamond Risk Management 18
The market has reliable risk measures for The market has reliable risk measures for individual portfolios, but no highly reliable individual portfolios, but no highly reliable
measure for total risk across the trading book and measure for total risk across the trading book and banking book .banking book .
CROs have benefited from significant progress made in measuring market & credit risk and are now attacking Operational Risk…. but have not yet found a generally accepted Unified Risk Measure
Black Diamond Risk Management 19
l The implementation of best practice calls for methodologies that accurately value transactions and quantifies the return to risk relationships of the individual as well as portfolio of transactions.
IndependentFirst-Class
Proactive RiskManagement
Performance
Vetting &Valuation Stress Testing
VaR
Valuation and Performance
Black Diamond Risk Management 20
Infrastructure: Ongoing assessment of infrastructure involves such questions as:
Are the appropriate people and operating elements in place to control and report on risk? Are there periodic risk management change initiatives?
AccurateData
Operations
People(Skills)
IndependentFirst Class
Proactive RiskManagement
Technology
Black Diamond Risk Management 21
Risk Management Change Initiative Questionnaire
QUESTION
What major themes underlie your business strategy as a whole?
Does this represent a major departure from the past? In what ways?
What are your three most critical deliverables this year? What are the most likely impediments to success?
Is there a single metric or set of metrics that is most important to you as your monitor progress against your goals?
COMMENTSCATEGORY
Self Description
Black Diamond Risk Management 22
Risk Management Change Initiative Questionnaire
CATEGORY QUESTION
How do you see the role of Risk Management changing in the context of your changing strategic Agenda?
How would this be different from the support you are currently receiving from Risk Management?
How do you believe Risk Management is doing in terms of meeting your regulatory/compliance requirements
Based on new/changing requirements, what do you feel we need to improve upon? Prepare for?
COMMENTS
Risk Management’s
Focus
Black Diamond Risk Management 23
Risk Management Change Initiative Questionnaire
CATEGORY
New
Requirements
No Longer
Required
QUESTION
Do you see Risk Management as a resource (problem solving)? How would you see that relationship playing out?
What are the values and principles that should guide Risk Management's relationship with its business partners?
Based on your new direction, what should RM be doing, that e are not currently doing, in terms of providing support to your business group?
Based on your business priorities, what should RM stop doing that adds any value?
Black Diamond Risk Management 24
Risk Management Change Initiative Questionnaire
CATEGORY QUESTION
What do you believe to be Risk Management's current strengths? What do we do well?
What do we need to do better?
Can you identify three issues/areas of concern, which you feel Risk Management adversely impacts on organizational effectiveness?
COMMENTS
GeneralAssessment