Garpwebcastmoodys062515 Unified Template

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Presented by:

Gudni Adalsteinsson Head of Global Liquidity, Group Treasury, Legal & General Group Plc

Nicolas Kunghehian Director Solutions Specialist, Moody's Analytics Pierre Mesnard Director, Solution Specialist, Moody's Analytics

June 25, 2015

GARP Webcast

Aligning Liquidity Compliance and the Business A Three Step Approach

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Gudni Adalsteinsson is the Head of Global Liquidity at Legal & General,

responsible for the overall liquidity and cash management. His experience

ranges from running the group treasury for a European bank during the

credit crunch, working for the Financial Services Authority, to providing

liquidity advice to UK banks. Adalsteinsson was a group treasurer for an

Icelandic bank during the unprecedented liquidity shocks of 2008, which

offered him first-hand experience of liquidity risk management under severe

crisis. Between the years of 1998 and 2005, he was an executive director at

Lehman Brothers and Credit Suisse in London and Frankfurt, advising

German banks on their liquidity and structured credit investments. He has

been a board member of banks in the UK and Denmark.

Adalsteinsson holds an MBA degree from the University of Cambridge and a

bachelors degree in economics from the University of Iceland. He is the author of the book, The Liquidity Risk Management Guide from Policy to Pitfalls (Wiley, 2014)

Gudni Adalsteinsson, Legal & General Group Plc

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Nicolas Kunghehian is a Director, Solution Specialist at Moodys Analytics. He joined Moodys Analytics via Fermat in 2005, working as a specialist on our Asset and Liability Management, and Regulatory Compliance Solutions.

Before joining Moodys, Nicolas had over six years experience as an ALM and risk manager in two French Banks, Credit Agricole and Caisse Nationale des

Caisses dEpargne.

Nicolas holds a mathematics and economics degree from the Ecole

Polytechnique and a finance and statistics degree from the Ecole Nationale de

la Statistique et de lAdministration Economique, two prestigious French Grandes Ecoles.

Nicolas Kunghehian, Moodys Analytics

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Pierre Mesnard is a Solution Specialist at Moodys Analytics. Based in Paris, he works closely with Financial Institutions across the EMEA region,

advising them on how effective liquidity management and compliance can be

implemented with Moodys Analytics.

Pierre joined Moodys Analytics in 2007, and prior to joining, Pierre was a project manager in a consulting company where he advised major industrial

groups on their IT infrastructure and processes.

Pierre holds a Telecommunications Engineering degree from Tlcom

ParisTech (France).

Pierre Mesnard, Moodys Analytics

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Liquidity Risk Challenges

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Agenda

The Data Conundrum

BASEL III Opportunity To Get It Right!

The Adequate Framework

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The Data Conundrum

Sets liquidity risk management apart from other risk factors in banking

The reason for liquidity risk management still being relatively young

Impacts the whole spectrum of liquidity risk management from academic research to cash flow projections

Lack of standardisation of definitions and methods, BASEL III the first attempt to set the playing field

Will change the future research methods and methodologies

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The Data Conundrum, cont.

Example where lack of data drives liquidity management

PWC, Balance Sheet Management Benchmark Survey, Status of Balance Sheet Management

Practices among International Banks 2009, and PWC, April 2010

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Prescribed definitions on what is low risk, retail etc.

Management tool or compliance exercise?

100% LCR = GOOD, 99% LCR = BAD?

Forecasting LCR > Important feature and data requirement

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Standardised assumption and view on the balance sheet

Not being able to forecast NSFR levels bring high level of risk and inefficiency

Bank A NSFR Solution

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To fix one only problem albeit a big one: Maturity Mismatch

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The Adequate Framework

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A Recipe for an Adequate Framework

List of essential ingredients

Cash flow projections

Stress testing

Contingency planning, early warning indicators and risk metrics

Policies

Governance structure

Funds transfer pricing (FTP)

Monitoring, reporting and an escalation framework

How to get the ingredients to stick together?

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The 6 Step Framework

6. Reporting &

management

information

5. Stress testing

and CFP

4. Quantitative

framework

3. Governance and

high level policies

2. Risk Appetite

1. Sources of

liquidity risk

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Determining the Stability of Funding Scorecard Approach (50 Shades of Grey)

Channel

premium

(1-5)

Not DGS

covered

(+3)

Rate

sensitivity

(1-5)

Response

to neg.

news (1-5)

No other

relationship

(1-5)

Size

premium

(1-5)

Total

Score

Unsecured debt, branch network

1 Retail, branch network - covered by DGS

1.1 part of an established relationship making withdrawal highly unlikely; 1 1 1 3

1.2

held in a transactional account, incl. accounts to which salaries are regularly

credited. 1 1 1 3

1.3 other, covered 1 1 1 2 5

2 Retail, branch network - not covered by DGS, but less than 500k 1 3 1 1 2 2 10

3 Retail, branch network - not covered by DGS, >500k 1 3 2 1 2 4 13

4 SME, branch network - covered by DGS

4.1 part of an established relationship making withdrawal highly unlikely; 1 1 1 3

4.2 held in a transactional account 1 1 1 2 5

4.3 other, covered 1 1 1 2 5

5 SME, branch network - not covered by DGS

5.1 part of an established relationship making withdrawal highly unlikely; 1 3 1 2 7

5.2 held in a transactional account 1 3 1 2 2 9

5.3 >500k 1 3 2 2 2 3 13

5.4 Other (i.e. non -transactional 500k 1 3 2 2 2 4 14

6.4 other (i.e. non -transactional 500k 3 3 3 3 2 4 18

Unsecured debt, treasury

10 NBFI (non-bank financial institutions),

10.1 part of an established relationship making withdrawal unlikely; 5 3 3 3 4 18

10.2 held in a transactional/custody account 5 3 3 4 2 4 21

10.3 other 5 3 5 4 2 4 23

11 Governments, central banks and supranationals

10.1 part of an established relationship making withdrawal unlikely; 5 3 3 3 4 18

10.2 held in a transactional account 5 3 3 4 2 4 21

10.3 other 5 3 5 4 2 4 23

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Determining the Stability of Funding Scorecard Approach

The above categories can be the ones set out in BASEL III

One or two sets of data?

+ Standardisation

- One size fits all bulk approach

+ Eliminated confusion

+ Cost

+ Will become a local requirement

Total

Score Amount $ %

Stability I 10 1,500 10%

Stability IV 10 1,500 10%

Stability VI 20 700 5%

Weighted average score: 6.5 15,500 100%

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Scenario Stress Testing

Bank A: Liquidity Stress Test Scenarios

No

Firm-specific/ market

wide/ Combination Working title Short Description

1 C GREEN Business as usual

2 F Creditworthiness I Sudden event leading to a drop in market confidence

3 F Creditworthiness II Prolonged lack of market confidence

4 F Operational failure IT failure leading to client payment failures

5 C YELLOW All major stress factor started to strain

6 F Northern Rock Adapted Northern Rock style scenario

7 C AMBER All stress factor materially affected, incl. collateral

8 M EuroZoneWide interbank disruption due to Eurozone problems or

break-up

9 M Market trouble On going disfunction of the interbank markets

10 F Creditworthiness IIISudden event leading to progressively deterorating situation.

Contingency actions included

11 M 9/11 Global market wide disruption across markets and products

12 C REDSevere outflow of deposits, interbank market in crises mode,

market for collateral disrupted, increased haircuts

- Liquidity holding requirement set according to AMBER results

- For stress assumptions see 'Liquidity Stress Testing -Assumptions and methods' in 2014 ILAA

-In addition to the 12 scenarios ALM has monitored the outcome of 4 other models

-The scenarios include sensitivity analyses for the major variables

-Approved by ALCO, reviewed annually

The following test are conducted monthly and reported to ALCO and senior management

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Scenario Stress Testing

Scenario 2: Sudden drop in market confidence

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Scenario Stress Testing, cont.

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Liquidity Compliance and Business Management Feedback From the Market

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Evolution of Liquidity Management

Before the liquidity crisis

Treasury was the only department dealing with Liquidity Risk

Liquidity Risk was considered as small

P&L was the main objective

Over the last years

Liquidity spreads => lower P&L

Risk of bankruptcy => more risk

Regulatory pressure => more reports to produce

Data governance

Stress testing => more data in a short period of time

Consolidated reports => different jurisdictions

Top management => internal communication

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Before the Crisis

Only one team in charge

Treasury or ALM department

Strong expertise

Customized internal tools

Three horizons

Intra day liquidity management

Short term

Long term

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New Missions

1. Liquidity risk management

Treasury or Risk Department

First internal stress tests

Top management involvement

2. Regulatory pressure

Principles for sound liquidity risk management and supervision

Stress tests in some countries

3. Internal costs

Daily reports

Strategic vs tactical tools

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New Trends

1. Enterprise risk management

Integrating all risks in one single framework

BCBS 239

Monitoring all the costs (Funds Transfer Pricing)

2. Regulatory impact

LCR cannot be calculated with Excel tools => need for industrialization

Managing the ratios and their volatility

3. Performance monitoring

Governance

Liquidity Transfer Pricing

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Three Steps to Delivering Integrated Liquidity Compliance and Business Management

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Three Steps to Delivering Integrated Liquidity Compliance and Business Management

1. Modelling financial instruments / cash flow generation (or import)

Maturing products / Non maturing products

Off balance sheet commitments / Derivatives

Liquid / illiquid asset (contingency funding plan, liquidity buffer)

2. Implementing compliance rules and setting internal liquidity policy

Regulatory inputs (haircuts, eligibility criteria, run offs)

Scenarios behavioural assumptions (shifted run offs, prepayments)

3. Reports disclosure

Regulatory reports (LCR / NSFR, ALMM, FSB)

Consolidation

Internal liquidity dashboards

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What Do We Mean by Unified Data Platform ?

Granular data loading and checking needed

- Easier to aggregate information when available rather than trying to get /

guess missing information

A mix between risk and finance information

- Cash flows projection based on Financial Characteristics

- Security classification criteria based on Risk profile (Rating, Asset Class,)

Consolidation of the entire balance sheet

- All products coming from all business lines

- Solo and group calculations (definition of transferable rules)

A central repository to simplify all adjustments process

Delivery of results with full and comprehensive auditability

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Implementing a Unified Platform Offers to Go Beyond Regulatory Compliance Implementing a Unified Platform Offers to Go Beyond Regulatory Compliance

Best

Practices

Regulatory

Compliance Liquidity Management

Liquidity

Pricing

Stress testing

methodologies

Regulatory

Compliance

Liquidity

Management

Stress

Testing

Methodologies

Liquidity

Pricing

Best

Practices

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In Addition to Regulatory Requirements, Banks Can Set Up Their Proper Liquidity Management In Addition to Regulatory Requirements, Banks Can Set Up Their Proper Liquidity Management Framework

Short Term Medium Term

ScopeEnsures that the bank can be financed

safely via secured short term funding

Enable the bank to forecast liquidity

requirements to sustain its activity / strategy

for the coming months / years

Calculation Frequency Daily or weekly Monthly

Stress Testing Scenario

N scenarios:

- on going,

- systemic crisis,

- specific (downgrade),

- specific + systemic crisis

-

Time HorizonMaturities monitored are 1D, 2D, 1W

until 3M

Maturities Monitored are 1M, 3M, 6M, 12M,

18M, 24M and 36M (not limited)

Perimeter Consolidated/Entity level

Approach Static approach Dynamic approach

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Regulatory Indicators Used to Complement Internal Liquidity Metrics

With increasing pressure from regulators, banks tend to rely on more automated process to generate final

regulatory returns

Process should be run daily

Full audit trail to understand calculation and track adjustments has to be recorded

Regulatory metrics have been widely incorporated in their dashboard: e.g. LCR forecast is now a standard

ratio to monitor liquidity

Based on regulatory parameters (run off, eligibility criteria)

Based on models developed by the bank

Data consolidated for regulatory purpose are also widely reused in balance sheet simulations to better

capture liquidity risk

Better reflect liquidity costs used by commercial unit

Impact of liquidity costs on banks net interest income

Impact of liquidity cost on EVE

Regulatory Indicators Used to Complement Internal Liquidity Metrics With increasing pressure from regulators, banks tend

to rely on more automated process to generate final

regulatory returns

- Process should be run daily

- Full Audit trail to understand calculation and track

adjustments has to be recorded

Regulatory metrics have been widely incorporated in their dashboard : e.g. LCR forecast is now a standard


- Based on regulatory parameters (run off, Eligibility

criteria )

- Based on models developed by the bank

Data consolidated for regulatory purpose are also widely reused in Balance Sheet simulations to better

capture Liquidity risk

- Better reflect liquidity costs used by commercial unit

- Impact of liquidity costs on Banks Net Interest Income

- Impact of Liquidity Cost on EVE

Regulatory Indicators Used to Complement Internal Liquidity Metrics With increasing pressure from regulators, banks tend

to rely on more automated process to generate final

regulatory returns

- Process should be run daily

- Full Audit trail to understand calculation and track

adjustments has to be recorded

Regulatory metrics have been widely incorporated in their dashboard : e.g. LCR forecast is now a standard


- Based on regulatory parameters (run off, Eligibility

criteria )

- Based on models developed by the bank

Data consolidated for regulatory purpose are also widely reused in Balance Sheet simulations to better

capture Liquidity risk

- Better reflect liquidity costs used by commercial unit

- Impact of liquidity costs on Banks Net Interest Income

- Impact of Liquidity Cost on EVE

Best Practices Stress Testing Creating a culture of risk awareness

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Risk Professionals

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+ 44 (0) 20 7397 9630

www.garp.org

2015 Global Association of Risk Professionals. All rights reserved.

About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to preparing professionals and

organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment

management firms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk

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Garpwebcastmoodys062515 Unified Template

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