Risk Management in Emerging Markets

Risk Management FunctionRisk Management FunctionBancoBanco

Santander Central HispanoSantander Central Hispano

Risk Management in Risk Management in Emerging MarketsEmerging Markets

BSCH Experience in Latin AmericaBSCH Experience in Latin America

Trinidad, February 2000



AGENDAAGENDA

BSCH - Firmwide Risk ManagementBSCH - Firmwide Risk Management

Risk Factors in Emerging MarketsRisk Factors in Emerging Markets

Implemementing Market Risk Management in Emerging MarketsImplemementing Market Risk Management in Emerging Markets

SummarySummary

Risk Management in Emerging Markets



BSCH - Firmwide Risk ManagementBSCH - Firmwide Risk Management

BSCH MissionBSCH Mission

Risk Management PhilosophyRisk Management Philosophy

Detailed FunctionsDetailed Functions

Business and Risk Management OrganizationBusiness and Risk Management Organization

Market Risk Management GroupMarket Risk Management Group




BSCH Risk Management Mission ...

The primary objective is to protect the capital of the firm,

maximizing the return on the capital invested.

Senior Management has assigned the Market Risk Function the responsibility to gather, analyze control and report the information regarding the market risk´s held by the firm in order to allow the risk takers, managers and other personnel

to understand and make informed decisions regarding the management and control of risks taken.

Firmwide Risk Management



BSCH Risk Management Philosophy ...• Independence from the Business Units

• Support for Informed Business Decision-making

• Local Expertise in Each Products

• Flexible Policies Adaptable to Local Risks and Structures

• Key Characteristics:

– Countries

– Global Products

– Business Objectives

• Maximized Return on Risk Adjusted Capital (RORAC); Reduced Risk

Firm´s Directive : No surprises in unexpected losses




BSCH Risk Management Function ... Ensure that business within the Firm do not expose the organization to

unexpected losses that could threaten the financial stability. Identify, analyze, measure and assess risk, with no surprises. Establish risk management policies and procedures. Monitor and Control Risk parameters and Management P&L. Set new product development guidelines and inclusion of new exposures

within the current framework. Propose capital allocation and portfolio management methodologies.




BSCH Business Organization ...

EUROPE

AMERICAS

ASIA PACIFIC

SECURITIESTRADING

GROUP

FUNDMANAGMNT

GROUP

CORPORATEFINANCEGROUP

OFFICES OFFICES OFFICES



REGIONAL MANAGEMENT

FU

NC

TIO

NA

L M

AN

AG

EM

EN

T




GLOBAL: GLOBAL: RISK COMMITTEERISK COMMITTEESr Management By Country

Risk Aooetite By Risk Taker

Trading/ALM

LOCAL:LOCAL: ALCOCOMMITTEE ALCOCOMMITTEE

GLOBALGLOBALMARKET RISKMARKET RISK

Risk Apetite by Local Sr. Management

Global Limits Distribution

Sublimits by Business Lines

LOCALLOCALMARKET RISKMARKET RISK

MINIMUM REQUIRED CAPITALMINIMUM REQUIRED CAPITALPR

OP

OS

AL

PR

OP

OS

AL

AP

PR

OV

AL

AP

PR

OV

AL

VarDLoss TriggerStop LossGreeksVol Eq,...

Sens MVESens NIM

Gap Concentration

NEGOCIACIÓN

BALANCE




Risk Management Organization

Market Risk Control

Methodology and Infrastructure

Global Head of Risk Management

Global Market Risk

RORAC

Regional Coordinator

Corp./Cpty

RiskCredit RORAC

Commercial Banking

Capital Markets/Structured Products

CRMG


… the ultimate responsible for Risk Management is the Chairman of the Firm



The Risk Management Landscape:


Price Risk

Liquidity Risk

Credit Risk

Settlement Risk

Operational Risk

Legal Risk

Loss in market value of a position

Inability to unwind a position/meet payment obligations

Loss due to inability of counterparty to perform legal commintment

Risk of no receiving funds/instruments at the expected time

Loss due to execution error

Risk that contracts are not legally enforceable or documented correctly

TradingBook

BankingBook

Global StructuralProducts



Independence from the Business AreasIndependence from the Business Areas

MirrorMirror the business structure in the organization of the market risk function. the business structure in the organization of the market risk function.

Help to ManageHelp to Manage dein a global view the dein a global view the Price and Liquidity RisksPrice and Liquidity Risks for the for the

different portfolios like different portfolios like Trading, Investment, ALM ...Trading, Investment, ALM ...

Identify and measureIdentify and measure the Risk effect in the economic value of the Balance Sheet the Risk effect in the economic value of the Balance Sheet

Assign the economic capitalAssign the economic capital in a homogeneous and consistent way in a homogeneous and consistent way..

Measure the risk from an Measure the risk from an economic perspectiveeconomic perspective independent from accounting effects independent from accounting effects

The accounting effect is another variable that affects the economic capital. The accounting effect is another variable that affects the economic capital.

Global Market Risk Group. Underlying Principles

Global Market Risk Principles...



RiskIdentification

Risk Estimated

Analysis ofPortfolios Take Risk?

Capital Allocation

P&L Measurement

Risk MeasurementInformation and Control

Business

PoliciesPolicies

Aprovals

Measures

Committees

MethodologiesMethodologies

ValuationValuation

MeasurementMeasurement

LimitsLimits

Global

Local

ReportsReports

Daily

Weekly

Monthly

Eficiency MeasuresEficiency Measures

Numerical: RORAC

Cualitative: ALCO

Committee

SI

NO

Global Market Risk Process...

Global Market Risk Group. Process



Breaking down the risks...Global Market Risk Group. Process

… Along different dimensions: Risk type - Interest Rate, FX, Equity, Commodity, Other (Basis, Vol, ...)

… to identify: Risk Concentrations

- whether large risks are due to size/nature of the position Diversification Benefits - Risk is not additive

- Total risk is less that the sum of the partsOpportunities

… and apply synergies from different business units: Analysis (Valuation, Risk Measurement) Information Technology (Intratet, Databases, Development) Management Information Systems

Flexible risk analysis and reporting us essential !!!



Market Risk MethodologiesStatic measures (FX, Equity exposure), IR sensitivity, Gap analysis, Greeks. VaR (Correlation)Scenarios from a Normalize market environmentVaR (Monte Carlo)

Scenarios from historical returnsVaR (Historical Simulation),

Ad-hoc scenarios, MaxVaR, Marginal VaR

Scenarios set in a complete social, political and economic context

•PARAMETRIC:

•MONTECARLO SIMULATION:

•HISTORICAL SIMULATION:

•STRESS TEST/ SCENARIO ANAL:

•EVENT RISK ANALYSIS




The Risk Management Group Should do more than just control...

• Evaluate Risk/Return

• Explore the exposures in a flexible way to identify Key Risk Sources / Concentrations

• Report your risk flexibly to deliver the right amount of detail

• Experiment with alternative strategies

THE RISK MANAGEMENT GROUP SHOULD PLAY AN ACTIVE DECISION-MAKING ROLE




• Local Market Risk Unit provides local control and local product expertise

• Global Market Risk Areas (e.g., Technology, Quantitative Analysis) provide specific support services

• Global Market Risk Unit is fully informed of all local Market Risk decisions

• Requests for limits are coordinated by local Market Risk Function and forwarded to the Global Team for review and approval

Local Market Risk Committee

Local ALCO

Local

Global Delegated Risk Committee

Global Market Risk Committee

Global

Pro

posa

ls

App

rova

ls

Local Market Risk Function



Local Market Risk Function

Determine and Apply the Methodologies of:Determine and Apply the Methodologies of:• Portfolio ValuationPortfolio Valuation • • Risk MeasurementRisk Measurement

Identify, Measure and Analyze all Market RisksIdentify, Measure and Analyze all Market RisksManagement (MTM) P&L:Management (MTM) P&L:

•Define the valuation criteriaDefine the valuation criteria • • Implement Global modelsImplement Global models

Propose and Control of all Market Risks LimitsPropose and Control of all Market Risks LimitsFulfil the Market Risk PoliciesFulfil the Market Risk PoliciesAdapt the Recommendations of:Adapt the Recommendations of:

• Local RegulatorsLocal Regulators • Central Banks• Central Banks

OBJETIVE: • REINFORCE THE LOCAL UNIT ROLEOBJETIVE: • REINFORCE THE LOCAL UNIT ROLE

• • CREATE A GLOBAL RISK CULTURECREATE A GLOBAL RISK CULTURE



Risk Factors in Emerging MarketsRisk Factors in Emerging Markets

Fixed Income ProductsFixed Income Products

Local and International EquitiesLocal and International Equities

Foreign ExchangeForeign Exchange




Local & External Debt: Brady, Eurobond, Govt There is no homogeneous Country Yield curve

There is almost no country with the same structure of local FI markets

There are almost no mechanisms to arbitrage/hedge the local curves

Different measures quote bonds that create inefficiencies:

Sobretasa (Mex), Nominal-Real curve (Chile,Mex,Col)

Amortising/Capitalising Debt (Argentina), 15 day - 20 year 5 quote YC (Chile)

Business-days daycount (Brazil), Survey YC quotes (Peru)

Stripped Yield, Blended Yield, IR Duration, Stripped Duration

The products are driven by exogenous factors (liquidity, investors, …)

Limited repo market, almost no short sales (except synthetic products)

Fixed Income Products



Equities: Betas? Correlation? Liquidity?

The Liquidity in the market is far below the Developed markets (see table)

The Market Valuations are not comparable with Developed Markets (see table)

Volatility needs to be measured in local and US dollar returns

Correlation has limited effect and may be volatile

The CAPM model needs to be adjusted … but how?

Proxy assignment?? How?

There is still a chance … the ADR and GDR market

Local and International Equities



FX: Is the history reliable?

Most EM countries have experienced FX control regimes (bands, fixed rate)

The last five years has witnessed the change in those controls, with important adjustments in the FX rate.

Volatility changes considering the historical period.

Correlation has limited effect between currencies and may be volatile

Macroeconomic models are not reliable to measure the timing of a FX crisis

Foreign Exchange Markets

FX Daily Return Correlation: 1997 - 1999

AR BR CH CO MX PE VE JP UKArgentina 1 -28% -18% -16% -17% -25% -19% -5% 1%

Brasil 1 90% 85% 70% 94% 87% 8% 2%Chile 1 94% 82% 95% 96% 5% -1%

Colombia 1 84% 93% 96% -4% -3%Mexico 1 88% 88% -1% -3%

Perú 1 -3% 0% 0%Venezuela 1 -3% 2%



Implementing Market Risk Management Implementing Market Risk Management

in Emerging Marketsin Emerging Markets

Risk Management tools for Latin AmericaRisk Management tools for Latin America

IADB - BSCH ProjectIADB - BSCH Project




Risk Management in Latin America• Markets are illiquid, with an absence of financial benchmarks for valuation and

risk measurement.

• Some countries trade with a fixed or captive FX market.

• There are serious limitations with time series, being unable to compute reliable volatilties and correlations.

• Some local products have unique characteristics.

• There is a limited investment in IT systems and valuation tools.

• Difficult to find qualified professionals in Risk Management, which stresses the need to increase training in the Risk Management arena.

Risk Management tools for Latin America



Markets without memoryMarkets without memory

Very IlliquidVery Illiquid

Risk Factors not measurableRisk Factors not measurable

Mix of Price/Liquidity & Credit RiskMix of Price/Liquidity & Credit Risk

The Models are unable to reflect the extreme casesThe Models are unable to reflect the extreme cases

Additional Qualitative MeasuresAdditional Qualitative Measures

CUANTITATIVECUANTITATIVE•BACKTESTINGBACKTESTING

•STRESS TESTSTRESS TEST

•ESCENARIOSESCENARIOS

NUMERICAL RESULTSNUMERICAL RESULTS

QUALITATIVEQUALITATIVE•CONTINGENCY PLANSCONTINGENCY PLANS

•NON MEASURABLE FACTORSNON MEASURABLE FACTORS

•DETAILLED KNOWLEDGE OF POSITIONS ANDDETAILLED KNOWLEDGE OF POSITIONS AND

MARKETSMARKETS

•CONTINUOUS COMMUNICATION BUSINESS/RISKSCONTINUOUS COMMUNICATION BUSINESS/RISKS

DISCUSSION ARENA:DISCUSSION ARENA:

ALCO COMMITTEEALCO COMMITTEE

MARKET RISKMARKET RISK

MANAGEMENTMANAGEMENT

Risk Management tools for Latin America



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Rdo Diario VaR 3 std VaR 1.65 std

TOTAL PORTFOLIOTOTAL PORTFOLIO

Management P&L vs Value at Risk (VaR)Management P&L vs Value at Risk (VaR) Fecha del Infome: 22-Jun-99Fecha de Cierre: 21-Jun-99

Todas las cifras en millones USD

BSCH Market Risk Profile in Latin America



Starting point: BS Chile - BS PerúMarket Risk Model Proposal

• Common Issues

– Both are companies within BSCH, with a common culture in Risk Management and Control

– Have a previous Risk Management and Control model

– Control has Independence from the Business group

– Past Culture in IR Gaps

– Employ Market Risk methodologies, although not

– Absence of an integrated system solution

– Problems with the MIS system, procedures and training

IADB - BSCH Project



Differences and StrategiesBS ChileBS Chile BS PerúBS Perú

MarketMarket

Total AssetsTotal Assets

In BSCH forIn BSCH for

StrategyStrategy

OrganizationalOrganizationalStructureStructure

Medium LiquidityMedium Liquidity

8.000 MM USD 8.000 MM USD (2º)(2º)

15 years15 years

Low LiquidityLow Liquidity

Minor changes in Minor changes in functions & functions & committeescommittees

Market data Market data captured dailycaptured daily

GlobalRiskGlobalRiskImplementarionImplementarion

1.000 MM USD 1.000 MM USD (7º)(7º)

3 years3 years

Customized Customized applicationapplication

Data estimationData estimation

Creation of the Creation of the Market Risk Market Risk

groupgroup

MarketMarketVariablesVariables

InformationInformationSystemsSystems

DifferencesDifferences

IADB - BSCH Project



Market Risk model proposed:

Determine the criteria Determine the criteria to take riskto take risk

Determine the criteria Determine the criteria to take riskto take risk

Decision Making ProcessDecision Making ProcessDecision Making ProcessDecision Making Process

Análisis y Evaluación deAnálisis y Evaluación delos Riesgos Existenteslos Riesgos Existentes

Análisis y Evaluación deAnálisis y Evaluación delos Riesgos Existenteslos Riesgos Existentes

P&L Behaviour vs Risk TakenP&L Behaviour vs Risk TakenP&L Behaviour vs Risk TakenP&L Behaviour vs Risk Taken

LimitLimitStructureStructure

LimitLimitStructureStructure

RiskRiskAnalysisAnalysis

RiskRiskAnalysisAnalysis

Risk Risk ManagementManagement

Risk Risk ManagementManagement

PerformancePerformanceMeasurementMeasurement

PerformancePerformanceMeasurementMeasurement

ImplementationImplementation

OrganizationOrganization

PoliciesPolicies

ProceduresProcedures


SystemsSystems

ControlsControls

TrainingTraining

ImplementationImplementation

OrganizationOrganization

PoliciesPolicies

ProceduresProcedures


SystemsSystems

ControlsControls

TrainingTrainingControl del perfil deControl del perfil deRiesgoRiesgo

Control del perfil deControl del perfil deRiesgoRiesgo

RiskRiskControlControl

RiskRiskControlControl

M.I.S.M.I.S.M.I.S.M.I.S.

IADB - BSCH Project



SummarySummary




Risk Management Project - Key Factors for Success

• Country Analysis

• Clear determination of Goals

• Compromise from Local Senior Management

• Total commitment from the key departments

• Personalized solutions for each market/financial institution

• Training and Mentoring the local personnel

IADB - BSCH Project



… But always be careful with ...

• Liquidity and Market environment

• Discontinuities in prices

• Market Depth and characteristics

• Model Risk

• Training and Human Resources conflicts

• Regulatory Issues

IADB - BSCH Project



Limit StructureLimit Structure

InfraestructureInfraestructure

and Systems and Systems

OBJETIVES:OBJETIVES:

Short Term - No surprises to unexpected lossesShort Term - No surprises to unexpected losses

Long Term Achieve an Efficient Managemnt of the Firm´s CapitalLong Term Achieve an Efficient Managemnt of the Firm´s Capital

Control and ReportingControl and ReportingMethodologyMethodology

Policies and ProceduresPolicies and Procedures

CAPITALCAPITAL

Measurement and Measurement and

Valuation ToolsValuation Tools

Summary - Risk Management in Emerging Markets




Annex - Graphs forAnnex - Graphs for

External Interest Rate RiskExternal Interest Rate Risk

Internal/Local Interest Rate RiskInternal/Local Interest Rate Risk

Equity RiskEquity Risk

Foreign Exchange RiskForeign Exchange Risk




Rep 01

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Rep 05 Rep 09 Rep 17Rep 27

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ARGENTINA: USD Debt (Global vs Domestic & Brady)Stripped Spread vs Stripped Duration

Bonte 01

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Bonte 04Pre 1Pre 3

Pro 1

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ARGENTINA: ARP Debt (Bonte vs Pre´s-Pro´s)Stripped Spread vs Stripped Duration



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US 10 años EURO 10 años Japon 10 años

Evolucion de los Indices de Renta Fija - Mercados Desarrollados




Long Term Interest Rates BehaviourLong Term Interest Rates Behaviour

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EMBI Global EMBI Latam EMBI Asia

Evolucion de los Indices de Renta Fija - Mercados Emergentes




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Indice EMBI Global - Spread sobre Bono Americano




Argentina - Interbancario Pesos 90 d

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Correlation Analysis: Stock Markets vs IR (1990 - 1999)

90d TBill 30yr TBond Spread S&P 500

IFC - EMERGING -23% -41% -9% 30%IFC - LATAM -39% -59% -7% 56%IFC - ASIA -8% -10% 0% -9%IFC - EMEA 65% 0% -68% 22%

Latin AmericaArgentina -40% -70% -15% 70%Brazil -7% -63% -44% 73%

Chile -17% -54% -26% 50%Colombia 26% -26% -38% 29%Mexico -64% -41% 33% 26%Peru 76% -5% -67% 45%

Venezuela -15% -15% 22% 22%



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Indices expresados en base $USD. Punto referencia 1 Enero 97.




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Evolucion de las Principales Monedas en Latinoamérica


Risk Management in Emerging Markets

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