Financial Risk Management 4003

8/8/2019 Financial Risk Management 4003

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Financial RiskManagementKPMGADVISORY


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A spate o high-profle business ailures and the emergence o tougher regulations have put organizations under pressure to

manage fnancial risk more eectively. Financial organizations have to be aware o the need to identiy, measure and manage

risk, e.g. credit, market, liquidity, and operational risk, as well as maintaining sufcient levels o regulatory and economic

capital to support the risks they ace. Also, there is a need or adequate disclosure and presentation o inormation to

stakeholders and third parties.


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Financial Instruments Valuation / Accounting and Disclosure

Financial instrument valuations encompass valuations o a variety o simple, complex andstructured products. Examples o such products are credit derivatives (e.g. Credit Deault

Swaps), interest rate and oreign exchange derivatives (e.g. Interest Rate Swaps, Cross

Currency Interest Rate Swaps, Interest and Foreign Exchange Rate Options, Swaptions,

etc.), Credit Link Notes and Total Return Swaps. Moreover, recent developments have

raised issues around the valuation o Asset Backed Securities (ABS), Collateralized Debt

Obligations (CDO) and related structures. Clients oten raise questions such as: Do we

have a reliable market value? Do we use an appropriate valuation model? Is the outcome

o the model reasonable? We can assist in providing solutions in this area.

Our practice also provides support in the correct accounting o Financial Instruments,

in accordance with IFRS, US-GAAP or other accounting standards. An example would

be the review and implementation o Hedge Accounting where the appropriateness o

(Fair Value/Cash Flow) Hedge Accounting model and Hedge Accounting eectiveness

tests are evaluated . In addition, we have wide experience in the preparation o fnancial

reporting disclosures o fnancial instruments, risk management methods and models

(e.g. IFRS 7, Disclosure requirements acc. to Pillar 3 o Basel II).

Capital Adequacy, Regulatory Reporting & Compliance

Capital Adequacy or banks is calculated and

Regulatory Reporting is made according to

regulators rules and methodologies, defning

or each bank a minimum regulatory capital

requirement and reporting. It comprises, but

is not limited to, the Basel II ramework as,

e.g., transposed in Luxembourg with respect to

FinRep (Financial Reporting based on IFRS) and

CoRep (Common Reporting or the Solvency

Ratio based on IFRS) by the Commission de

Surveillance du Secteur Financier (CSSF).

Management o Financial Risks

The management o credit risk, market risk

(comprising interest rate risks, oreign exchange

risks, equity risk as well as commodity risks),

operational and reputational risk, insurance

risk as well as liquidity risk should be part

o every sound fnancial risk management

system within a company. The scope

depends on the relevance o each risk

category or a company. Most institutions

measure their risks based on Value-at-

Risk Models. Many o these risks are highly

relevant or most o the fnancial institutions

and are interrelated. As such, they need to

be measured and managed accordingly. Recent

developments have revealed signifcant weaknesses in the management o credit risk

and liquidity risk within many organizations. Sound credit risk management can mitigate

or avoid a signifcant fnancial impact o such events on an organization.

What We Do And What You Get

Basel II Framework - 3 Principle Pillars

Minimum

Regulatory

Capital

Requirement

Supervisory

Process

Market

Discipline

Your potential benefts are :

An adequate and tailor-madeapproach to any kind o fnancial

instruments valuation.

Third party valuation where youbeneft rom our valuation tools and

knowledge.

Compliance with regulatory andaccounting rameworks.

Eective implementation o Hedge

Accounting and other valuation tools

to mitigate volatility o accounting P&L.


Full compliance with regulatoryrequirements in Luxembourg.

Sound capital requirementcalculations especially or IRB

approach or credit risk and AMA

approach or operational risk.

Integrated and comprehensive

methods to implement or refne

existing processes to ulfll

regulatory requirements.


Improved transparency and enhanced

understanding o risks the company

is exposed to.

Identifcation o the dierent kinds orelevant risks and their key drivers.

Development and implementation oappropriate risk management models

and procedures.

Setting up a sound risk management

practice or those risks.


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Model Building and Model Validation

A model is a tool used to calculate or estimate

results based on a series o inputs oten used

or analysis or quantifcation. Models are used

to make decisions easier and as such they

support the decision process. They do not

have an own purpose. Organizations use

a wide variety o models or spreadsheets,

which can be broadly categorized into

three areas: Decision Support, Financial

and Risk Management models.

For example, structured products or Asset

Backed Securities are rarely priced on active

markets. Thereore, adequate fnancial models are

necessary to price those fnancial instruments. Furthermore, appropriate risk

management models adapted to the companies specifc purpose and needs, such as

Value-at-Risk or Expected Shortall, are needed to measure, manage and control the risk

thereo. The models underlying the Hedge Accounting eectiveness tests are another

example o models used in accounting.

ICAAP & Economic Capital Calculation

ICAAP (Internal Capital Adequacy Assessment Process), part o Pillar 2 within the Basel II

Framework, represents a fnancial institutions own assessment o the capital needed to

run the business. This capital may dier rom the minimum regulatory capital requirement

since, or instance, a fnancial institution may include risks that are not ormally subject to

the minimum regulatory capital (e.g. liquidity risk, reputational risk or interest rate risk in

the banking book) or may use dierent parameters or methodologies (this is particularly

the case or operational risk).

Restrictions dueto Basel II, Pillar II

!Economic

CapitalAvailableFinancial

Resources

Free Financial

Resources

Restrictions dueto Basel II, Pillar I

!Regulatory

CapitalPillar I

Own Funds

Capital Surplus


Development o eective models and

assistance in validating those models

as well as assessment o the overall

reliability o the model output.

Accurate pricing o fnancialinstruments based on efcient

and precise models.

Leading risk management models orsound fnancial risk management.


A risk management rameworkconsistent with fnancial risk strategy.

Efcient process in response to thesecond pillar requirements o

Basel II (ICAAP).

Full compliance with regulatory

requirements and in line with

best practice.

Adequate economic capital modelsand risk management processes and

procedures consistent to the risk

management ramework resulting

in a comprehensive and integrated

fnancial risk management approach.

Understanding o the dierent typeso risks fnancial institutions are

exposed to and how they impact

the company, incorporating theseinto their business operations and

monitoring.

Awareness o potential weaknessesin the fnancial risk management

strategy, rameworks and processesas well as in the risk mitigation

methods and being able to prepare

the management actions to be takento avoid unexpected or surprising

losses.


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Financial strategies could be risk avoidance, reduction, limitation, transerence or

acceptance. An integral part o fnancial strategies is the management o fnancial risks and

resources and comprises identifcation, measurement, assessment, controlling, monitoring,

reporting and stress testing o the several risks including risks essentially not integrated.

Risk Adjusted Perormance Calculations

Risk-adjusted perormance measures compare return with capital employed in a way

that incorporates an adjustment or risk. The most amous measures are RAROC

(risk-adjusted return on capital) and RORAC (return on risk-adjusted capital).

Risk-adjusted perormance measures are based on either risk adjusted return or

economic capital.They can be used or comparing past perormance or as a orward

looking measure to decide on the long-term viability o a business unit, whether

it should be expanded or scaled back.

Integrated Planning & Target Setting

Added Value (e.g., EVA)

Risk Cost

Cap. Cost

Value drivers/Operational Drivers/KPIs

Risk-Return Ratio (e.g., RORAC)

Revenue

Risk Aggregation

Cost

1

OrganizationalUnit

LegalEntity

Product

Customer

2 3 4 5

Market Risk Credit Risk Op. Risk Other Risks

Simulations & AnalysisReports/Cockpits

Expected Loss

Unexpected Loss

99.95% (AA)

EL

UL

0.00% 0.05% 0.10% 0.15% 0.20% 0.25% 0.30% 0.35%

ECAPPR

OBABILITY

LOSS RATE (%)

EL = expected loss

UL = unexpcted loss

ECAP = economic capital

AA = banks creditrating


Implementation o perormancemeasures or improvement o your

current measures.

Risk-adjusted perormance

calculations consistent and integrated

into existing capital planning and risk

management process.


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New Product Process (NPP) or Asset Management

Current market trends show that innovations o products and instruments will become

more signifcant over the coming years because o a decrease in market growth and a gain

in margin o traditional products. Standardized products such as index unds have lately

become more and more attractive or investors and alternative products are becoming

increasingly mainstream or asset managers.

An efcient and high quality New Product Process (NPP) is necessary to keep up

with the market demands and regulatory requirements or asset managers

Based on the increasing importance o new unding vehicles there is a need to accelerate

the time-to-market o new products while complying with applicable rules and regulations.

By launching new products asset managers are aced with a variety o challenges, e.g.

regulatory, economic, process-related and technical challenges. An efcient new product

process takes all essential departments and unctions o the value chain into account.

Our project management approach or the multidisciplinaryNPP A cube-based Illustration

Particular business unctions are involved in one or more phases o the NPP.

Cross-sectional issues come up or several business unctions during various phases.Our project management approach recognizes this variety and interconnection among

the various unctions.

- Callable Yield Notes- Callable Path Dependant Floaters- Certificates, Discount, Bonus, Express etc.- Basket Structures- Snowballs- Target Range Accrual Notes- Exotic Options Equity, Commodity etc.- Triggerable Reverse Floater- Inflation products, e. g. Zero Inflation Swaps,Inflation Swaps

- CPPI- Variance Swap- []

- Compliance with international regulatory guidelinesand local requirements (e.g. IFRS, InvG, SolvV, MiFID, AnlV,Derivative regulation)

- Coverage of permanently increasing requirements(Reporting, Corporate and Governance and Risk Management)in regard to regulatory law, accounting- and taxation law

- New products and instruments need to match with

the market expectations

- Product profitability

- Liquidity and risk performance

- Adequate mapping within the system and correct treatment

in the day-to-day business activities have to be assured

- Utilization of synergies

Modification / mixof existing products

Real innovations

New products

Regulatory

Economic

challenges

Process-related

technical

challenges

Fund managementMarket research

Legal

TaxInternal audit

Economic analysisTrading

Compliance

Order controlPricing & valuation

Risk analysisPerform. analysis

Fund accounting

Reporting

Initiation &Analysis Design Implementation Testing

Appproval &Going Live

Business

Functions

21

Cross-sectional

Issues

NPP Phases

3

Coordination

Communication

IT architectureInterfaces

Data

Execution (by default)


Ability to introduce new productsadequately and smoothly, minimizing

the time span rom the initiation

to going live and keeping track o

the expenses or related structures,

processes and IT.

Assurance o appropriate pricesand risk fgures with regard to new

products accommodating both

true innovations and modifcations

efciently.


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Financial Risk Management

Why ? Risk management is highly complex, with risks oten interrelated, which requiresophisticated tools and techniques. Sarbanes-Oxley, Basel II, Solvency II and the

cost o capital require organizations to improve their risk management practices.

This ultimately helps management to view risk as a major part o corporate

strategy. Financial risks are more and more interrelated to fnancial accounting

and reporting (e. g. IAS 39 and IFRS 7) as well as to the calculation o the solvency

ratio (e. g. calculation o the regulatory own unds based on IFRS). These require

integrated and comprehensive management rameworks to optimize Financial Risk

Management, Asset-Liability Management and overall product processes.

How can we help ? Based on an integrated approach, we can help design and implement rameworksto manage and/or reduce risk. We can provide assistance in creating an overall

ramework that helps to identiy, measure, monitor and report risks leading,

ultimately, to better strategic decision making and efcient processes.

Our quality ? In striving to provide high quality services, we participate in a global accreditationprogram, we work closely with proessionals rom other KPMG member frms,

liaise regularly with our global KPMG Financial Risk Management group and

share experiences on a variety o dierent national and international projects.

We also cooperate with universities to be able to provide the most up to date

methodologies to our clients.

Your beneft ? KPMG Financial Risk Management is committed to ensure that we are alwaysavailable to help identiy opportunities, solve problems and as a result add value

frm wide based on a multidisciplinary approach. You can beneft rom our cross-

border knowledge and experience in Luxembourg and abroad. Whatever problem

you might have regarding Financial Risk Management, we can provide you with a

tailored approach.

Your Needs Our Approach

Bank

s

InvestmentFu

nds

I

nsurances

Com

panie

s

Corpora

tes

Valuation

o FinancialInstruments

Capital Adequacy /

RegulatoryReporting

ICAAP&Economic

Capital

Calculation

Integrated and

Comprehensive

Risk Management

Model

Building &

Validation

Risk-adjusted

Perormance

Calculations

New

Product

Process

Accounting &

Disclosure oFinancial Instruments

Financial RiskManagement

(FRM)


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circumstances o any particular individual or entity. Although we endeavor to provide accurate and

timely inormation there can be no guarantee that such inormation is accurate as o the date it is

received or that it will continue to be accurate in the uture. No one should act on such inormation

without appropriate proessional advice ater a thorough examination o the particular situation.

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o KPMG International, a Swiss cooperative.

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Financial Risk Management 4003

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