Derivatives Valuation and Margin Calculations Pricing Deck - Feb... · 4 Background uSIMM...

Derivatives Valuation and Margin CalculationsWEBINAR | 27TH FEBRUARY 2018| 3PM GMT / 10AM EST

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Agenda

Welcome Ian Blance | Voltaire Advisors

1005 - 1015 Introduction: The ISDA SIMM | Ian Blance, Voltaire Advisors

1015 - 1030 ISDA SIMM: Derivatives Valuation & Margin | Dr. Russell Goyder, FINCAD

1030 - 1045 Initial Margin Under EMIR | Marc-Louis Schmitz, Finalyse

1045 - 1100 Audience Q&A

1100 Close of Webinar

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Introduction: The ISDA SIMMIan BlanceManaging DirectorVoltaire Advisors

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Background

u SIMM introduced by International Swaps Dealers Association (ISDA) in 2013 in response to financial crisis

u Live in September 2016

u Applies to non-centrally cleared over-the-counter (OTC) derivatives

u Standardized derivatives centrally cleared

u Part of a package of reforms to reduce systemic risk from OTC derivative markets

u Broader regulatory context increasingly complex and challenging for derivatives traders and users

5

SIMM

u Goal is to establish standard method for calculation of Initial Margin (IM) for non-centrally cleared OTC derivatives

u Consistency of application in wide variety of market participants

u Reduction in disputes over margin calculations

u Step 1 – Decompose portfolio into risk factors

u Step 2 – Calculate IM requirements

u Superficially fairly simple maths

u Subject to revision – Version 2.0 in December 2017

6

Challenges

u Data inputs – especially sensitivities

u Manual collateral processes

u Dispute definition and resolution

u Alternatives – Basel Committee approach

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ISDA SIMM –Derivatives Valuation & Margin

Dr. Russell Goyder, Director of Quantitative Research and DevelopmentFINCAD

© FINCAD

ISDA SIMMDerivatives valuation and margin

February 27, 2018

© FINCAD2

Russell Goyder, PhD, is the Director of Quantitative Research and Development at FINCAD. Before joining FINCAD's quant team in 2006, he worked as a consultant at The MathWorks, solving a wide range of problems in various industries, particularly in the financial industry.

In his current role, Russell manages FINCAD's quant team and oversees the delivery of analytics functionality in FINCAD's products, from initial research to the deployment of production code. Russell holds a PhD in Physics from the University of Cambridge.

Russell Goyder, PhDDirector, Quantitative Research and DevelopmentFINCAD

© FINCAD

Agenda

Challenges1

Best practice2

Conclusion3

© FINCAD

SIMM Structure

Standardized Sensitivities

Prescribed Weights and Correlations

SIMM Calculator Initial Margin

© FINCAD

garbage in

© FINCAD

© FINCAD

garbage out

© FINCAD

© FINCAD

ChallengesSpeed of sensitivity calculation

Portfolios and nettings sets

Standardized sensitivities

© FINCAD

Collateral optimization

Need for speed

Counterparty selection

Pre-trade analysis

TODO better for this to be an image conveying idea of need for speed with the text on top?

Collateral optimization

Counterparty selection

Pre-trade analysis

the need for speed

© FINCAD

© FINCAD

bump and grind

© FINCAD

© FINCAD

horizontal scaling

© FINCAD

© FINCAD

Risk ladders are not standardized

CashFRA orFutures

Swaps

Basis Swaps

Cash

Swaps

© FINCAD

Synthetic market data

Market instruments

Calibrate

Price

Standardized instruments

Pricing model Standardized model

© FINCAD

TODO Everest image or something to make the point that it is hard?

hard to get there

© FINCAD

© FINCAD

a patchwork of pricers

© FINCAD

© FINCAD26

TODO image for impossible to put back together like humpty or shattered glass

© FINCAD

the numbers don’t add up

© FINCAD

Agenda

Challenges1

Best practice2

Conclusion3

© FINCAD




Algorithmic Differentiation

Risk Reprojection

Analytics Platform

Best practice

© FINCAD

the past

© FINCAD

© FINCAD

current.

AlgorithmicDifferentiation

© FINCAD

the future

© FINCAD

© FINCAD

0

5000

10000

15000

20000

25000

30000

35000

40000

0 37 74 111

148

185

222

259

296

333

370

407

444

481

518

555

592

629

666

703

740

777

814

851

888

925

962

999

1036

1073

1110

1147

1184

1221

1258

1295

1332

1369

1406

1443

1480

1517

1554

1591

1628

1665

1702

seco

nds

# of risk factors

Cost of Risk - UAD v.s. Bumping

UAD Bumping Best Fit

© FINCAD

0

2

4

6

8

10

12

Porfolio IR Swaps Swaptions CDS FX Forwards Caps and Floors Equity Options FX Options

mill

iseco

nds

Cost Per Trade

Value Risk

© FINCAD

0

20

40

60

80

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120

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American Options TARF Basket Options

mill

iseco

nds

Cost per Trade - Exotics

Value Risk

© FINCAD





Risk Reprojection

Analytics Platform

Best practice

© FINCAD

Risk Reprojection

Portfolio (netting set)

Standardized Instruments

Market Data

1

2

3

© FINCAD

reprojected sensitivities

© FINCAD

© FINCAD





Risk Reprojection

Analytics Platform

Best practice

© FINCAD

Analytics Platform

Analytics Platform

Services API

Distributed Calculations

Caching Data Integration

Admin Data Storage

Python/Excel Other ApplicationsPortfolio and Risk

Portfolios Market Data Reference Data

© FINCAD

Agenda

Challenges1

Best practice2

Conclusion3

© FINCAD





RiskRe-projection

Analytics Platform

Best practice

© FINCAD

Enterprise portfolio and risk analytics for multi-asset derivatives and fixed income.

Out of the box, and customizable - No compromises

Improved Decision MakingFosters collaboration from creating ideas for investment strategies, through trading, to ongoing risk management.

Shared Data and AnalyticsConsistent input data and analytics for consistent results from front to middle office, reducing reconciliation issues and disagreements

Transparent and FlexibleTrace the lineage of results supported by a full audit trail of changes. Customizable analytics and reporting.

© FINCAD

“F3 is the most flexible valuation and risk analytics solution on the market that we could find. the ability

to develop and implement highly tailored hedging strategies and produce intra-day risk has been

extremely valuable for our team.”

− Senior Manager, Portfolio Management, UK Pension Scheme

© FINCAD

© FINCAD

FINCAD is the leading provider of enterprise portfolio and risk analytics for multi-asset derivatives and fixed income. An industry standard since 1990, our advanced analytics, flexible architecture and patented technology enable financial institutions to make better investment and risk decisions. Our goal is to provide our clients with solutions that help them achieve their goals, with no compromises. Clients include leading global asset managers, hedge funds, insurance companies, pension funds, banks and auditors.

For more information:North America 1 800 304 0702

[email protected]

Europe00.800.304.07020

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Initial Margin Under EMIR

Marc-Louis SchmitzPartnerFinalyse

Brussels I Amsterdam I Luxembourg I Budapest I Warsaw

Finalyse Valuation Service

Initial margin under EMIR

Marc-Louis Schmitz27/02/2018

By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.

To regulate the OTC derivatives market following the 2008 financial crisis. In particular:

• Reduce the counterparty risk• Improve transparency• Mitigate the systemic risk• Reduce the operational risk• Prevent future financial system

collapses

Clearing

Reporting Risk mitigation

Why EMIR? What does the EMIR cover do?

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ü Payment made to the counterparty on a daily basis to cover the current exposure of derivatives contracts. In the case of OTC derivatives, it should be equal to the positive mark-to-market value.

ü Calculated and exchanged daily (subject to MTA).

Variation Margin

ü Payment made to cover a potential exposure during the time between the last exchange of the variation margin and the liquidation of the position following a default of the counterparty: typically 10 days with 99% of confidence.

ü Rarely in use before EMIR

Initial Margin

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Both counterparties that have (or belong to groups which have) an aggregate average notional amount of non-centrally cleared derivatives above…

…should comply with the initial margins by the date specified above.

Under EMIR there are exemptions from the margin requirements for intragroup transactions (provided certain conditions are met).


1st September

2020

1st September

2019

1st September

2018

1st September

2017

4th February

2017

EUR 3,000 bn EUR 2,250 bn EUR 1,500 bn EUR 750 bn EUR 8 bn

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• Notional weighted according to the asset class and added up.

• May lead to unnecessarily large and costly requirements on capital.

• As it treats all securities of given class equally, it does reflect the risk of more exotic securities.

• Simple

• But is “Hammer to kill the fly” for most who have reasonably safe securities.

Asset Class IM (% of Notional)

Credit (0-2) years 2%

Credit (2-5) years 5%

Credit 5+ years 10%

Commodity 15%

Foreign Exchange 6%

Interest Rate (0-2) years 1%

Interest Rate (2-5) years 2%

Interest Rate 5+ years 4%

Other 15%

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• Counterparties are allowed to develop their internal model.

• Internally tailor-made for the securities and the exposures actually being held.

• Accounting for their sensitivities and covariance's within portfolio.

• Number of modelling options (under some prescriptions)

• Costly model development and governance.

Comparison Internal Model

Schedule-based Method

Representation of exposures

Tailor made to represent the exposures

Made to represent generic (risky) exposures

Capital Burden Capital reflects the exposures

Unduly high capital requirement

Modelling difficulties

Complicated model development

Easy to use

Agreement with counterparty

Counterparties will need to agree on models.

Standardized

Supervision Needs to be approved

Comes from supervisors

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An attempt to make the best of the two worlds :

• Licensed and maintained by ISDA

• New version in Dec 2017• Ease of replication• Transparency• Good calculation Speed• Extendibility to new risks• Predictable capital allocations

Comparison Internal Model

Schedule-based Method

ISDA SIMM

Representation of exposures

Taylor-made to represent the exposures

Made to represent generic (risky) exposures

Is accurate in representing the exposures

Margi Burden Margin reflects the exposures

Unduly high Margin requirement

Margin reflects the exposures

Modelling difficulties

Complicated model development

Easy to use Development and governance taken over by ISDA –user friendly.

Agreement with counterparty

Counterparties will need to agree on models

Standardized Depends on the large level of consensus

Supervision Needs to be approved

Comes from supervisors

Is approved

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23By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.

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• May lead to a substantial decrease in initial margin requirements (as much as five fold for some of the benchmark portfolios).

• Offsets sensitivities of different deals within the risk classes.

• Accounts for diversification across risk classes (via the use of correlations in the aggregation) within each product class.

Nevertheless, ISDA SIMM does not cover the calculation of sensitivities themselves, and different models produce different sensitivities, so not all disputes will be avoided.

ISDA SIMM: Best solution

• Parties with long-dated trades that always follow the same direction

• Denominated in high volatility currencies.

Ø In those cases (and those cases alone) the schedule-based methodology may be simplest and most efficient.

Ø In all other cases: ISDA SIMM is likely to be preferable

For whom the ISDA SIMM may NOT be desirable

Based on a parametric VaR 10 days 99%.• Steps:

1. Valuation and greeks (Delta, vega, curvature) for each position2. Greeks will ideally be produced under CRIF (Common Risk Interchange Format)Ø The results of those two steps will depend on the model and market data

61By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.

TradeID ProductClass RiskType Qualifier Bucket Label1 Label2 AmountAmount

CcyXXX1 Credit Risk_CreditQ 7BED48 1 3Y 2,073 EURXXX2 Credit Risk_CreditQ 7BED48 1 5Y 27,968 EURXXX3 Credit Risk_CreditQ 7BED48 1 10Y 0 EURXXX4 Credit Risk_FX USD 7,001 EURXXX5 Credit Risk_IRCurve USD 1 2W Libor3m 0 EURXXX6 Credit Risk_IRCurve USD 1 1M Libor3m 0 EURXXX7 Credit Risk_IRCurve USD 1 3M Libor3m -1 EUR

– Risk weights and Aggregation

– Review every 10 days or after specific events– Bilateral– Back testing vs P&L


ProductClass

Initial Margin (IM)

RiskClassInterest

Rate Credit

(Qualifying) Credit (Non-Qualifying)

Equity Commodity FX

RatesFX 6,174,955 4,469,771 - - - - 3,221,217 Credit 2,530,838 5,948 2,511,539 - - - 62,146 Equity 2,717,771 108 - - 2,717,752 - -

Commodity - - - - - - -Total 11,423,564

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• Same logic of parametric VaR

• 4 risk classes, IR, FX, EQ, CO

• Both rely on delta and vega“greeks”

• Some of the requirements overlap, leading to lower costs

Similarities

• Credit is split across 2 risk classes in SIMM (qualifying/non-qualifying), 3 risk classes in FRTB (securitization, non-securitization, correlation trading).

• SIMM computes curvatures and transformation of vega, FRTB requires additional sensitivity to be calculated.

• SIMM does not allow offset between sensitivities in the same risk classes across different product classes.

• SIMM has two additional interest rate buckets.

• Weights and correlations are different.

Differences

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• Valuation of derivatives (and derivation of sensitivities) will be a key issue (on which the parties will need to agree) for both VM and IM

• Reconciliation and disputes resolution

• Difficulties to compute the exact profitability of each trade (MVA)

• Identification, separation and management of both legacy trades and newly compliant trades in large portfolios

• Review of the CSA

• Collateral management

Challenges

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Finalyse, a European-wide leading consultancy, was founded in

1988. The company has a demonstrated expertise in

valuation, risk management & regulatory compliance advisory,

providing the financial community with the expertise bridging

the gap between finance and technology.

At Finalyse we value expertise, team spirit, empowerment,

fairness and innovation.

Risk Advisory

Assistance in choosing and implementing the best solutions to measure, report and manage your risks.

Regulatory Compliance

Guidance and up-to-date solutions to comply with evolving regulatory requirements, such as PRIIPs, EMIR, Basel III/CRD IV, Solvency II, MiFID II, AIFMD.

Valuation Services

An independent, cost-effective and tailored service for the valuation and reporting of OTC derivatives and structured products. SIMM Licenced Vendor.

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66

Audience Q&A

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Thank You!

u Participants will receive a copy of the slide deck and a recording of the Webinar tomorrow.

u Webinar and associated Guide is part of our Current Issues in Valuation Series looking at topical pricing challenges

u This is a component of our VIVA program of fund valuation initiatives throughout 2018 – more details can be found here:

http://www.voltaireadvisors.com/viva.html

http://www.voltaireadvisors.com/viva.html

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Contact Us

Voltaire Advisors LLP

14 Wall Street No.1 PoultryNew York London

NY 10002 EC2R 8JRUSA UK

+1 800 317 1932+44 800 677 1694

[email protected]

Derivatives Valuation and Margin Calculations Pricing Deck - Feb... · 4 Background uSIMM...

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