The New Market Risk Framework

(1)

Risk

Deutsche Bank

The New Market Risk Framework

A

hi

th d

dli

Approaching the deadline

European Business School Regent’s College Chapter Meeting GARP

European Business School, Regent s College Chapter Meeting - GARP

Adolfo Montoro

Head of Traded Market Risk Economic Capital Methodology October 26th₂₀₁₁

(2)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

Conclusions & Q&A

- 39

For internal use only

Risk

Deutsche Bank Adolfo Montoro – The New Market Risk Framework: Approaching the deadline

(3)

Agenda

Agenda Item

Topics discussed

Pages

The development of a new market

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(4)

The development of a new market risk framework

Overview – Regulatory groups

Trading Book Group



Basel Committee on Banking Supervision

g

y g

Task Force on Market Risk



European Banking Authority



Basel Committee on Banking Supervision



Sub-group of the Policy Development Group



Co chaired by US Board of Governors of the



European Banking Authority



Sub-group of the Standing Committee on



Regulation and Policy



Co-chaired by US Board of Governors of the



Federal Reserve System (Mrs Norah Barger) and UK FSA

(Mr Alan Adkins)



Regulation and Policy



Chaired by French ACP (Mr Stéphane Boivin)



W k l

d i

d f

CRD III i

l

t ti

f



Supports PDG objectives

 Identify and review emerging supervisory issues; and,

 Where appropriate, propose and develop policies that promote a sound banking system and high supervisory standards



Work plan, derived from CRD III implementation, focuses

mainly on...

 Guidelines on Stressed VaR

 Guidelines on IRC



Work performed

 Revised Market Risk Framework (July 2009), IRC

 Guidelines (July 2009) and CRM Stress Test



These developments should be finalized by the end of

2011

 Requirements (February 2011)

 TBG Impact Studies

 Dialogue with industry associations and firms

 Interpretative issues (July 2011, last version)

 Fundamental Review of the Trading Book (ongoing)

For internal use only

Risk

26th_{October 2011} ₄

24/10/2011

(5)

The development of a new market risk framework

Overview – Evolution of the framework



Introduction of market risks in the 1988 Accord

January 1996 - Amendment to the Capital Accord to incorporate market risks



Revised in September 1997

Removal of the 50 % floor on specific risk

Qualitative and quantitative requirements

Specific risk surcharge aiming at event and default risks



Revised in July 2005

Clarification of the trading book definition

Prudent valuation

Alignment trading book and banking book requirements for standardized specific risk (incl. securitisation deductions)

Inclusion of event risk

Incremental charge for default risk

(6)

The development of a new market risk framework

Overview – Evolution of the framework (cont’d)



Weaknesses of VaR methodology

Fat tails

In September 1997, reiterated and reinforced in July 2005

(

)

Fat tails

Changes in correlations and volatilities

Intra-day risks

Intra day risks

Extreme market circumstances (event risk)



Increasing number of credit risk-related products in the trading book (CDSs, CDO tranches...)

g

p

g

(

,

)

Default and jump-to-default risks are increasing

Risks proved difficult to apprehend with VaR



Increasing number of structured products

Less liquid positions

Correlation risk



Expected increase in credit and liquidity risk held in the trading book

Initial response = a specific risk floor superseded by a set of multipliers ; then, improvements of the

For internal use only

Risk

26th_{October 2011} ₆

24/10/2011

(7)

The development of a new market risk framework

Overview – Evolution of the framework (cont’d)



Default Risk only

October 2007 - consultation document - Guidelines for Computing Capital for Incremental Default Risk in the Trading Book

(

)



Requirement derived from paragraphs 718(xcii) and 718(xciii) of the Basel II Framework (June 2006

comprehensive version)



Implementation by 1 January 2010 (for grandfathered firms)



Implementation by 1 January 2010 (for grandfathered firms)

(8)

The development of a new market risk framework

Market developments



Higher delinquency rates have lead to a repricing...

When extreme situations materialize…



Increased risk aversion and the effects on liquidity…

For internal use only

Risk

26th_{October 2011} ₈

(9)

The development of a new market risk framework

Market developments (cont’d)



Increased risk aversion and the effects on liquidity...

(

)

(10)

The development of a new market risk framework

Market developments (cont’d)



Increased tensions in the banking system...

(

)

For internal use only

Risk

26th_{October 2011} ₁₀

(11)

The development of a new market risk framework

Market developments (cont’d)



Increased tensions in the banking system...

(

)

(12)

The development of a new market risk framework

The key driver: assessing the performance of the VaR model and market risk



The situation confirmed most of the observations made in July 2005 !!

Credit Risk exposure increased relative to other exposure

y

g

measures during the financial crisis

Credit Risk related risk factors became (more) material (e.g. Bond/CDS Basis, Correlation-Risk)

Underestimation of migration risk

Misapprehension of default and jump-to-default risks



Modelling shortcuts proved incorrect - misuse of proxies in the pricing and risk measurement of securitisation

products... they are not bonds !

Misapprehension of correlations and volatilities

Misapprehension of liquidity

Number of regulatory Backtesting-Outliers increased significantly

120 Outliers for 15 banks with internal model approval in Germany in 20081

In general a significant increased of backtesting outliers has been observed in all BCBS member countries starting from July 2007

For internal use only

Risk

26th_{October 2011} ₁₂

24/10/2011 2010 DB Blue template

from July 2007

(13)

The development of a new market risk framework

The key driver: assessing the performance of the VaR model and market risk



The quality of prediction has to be tested on a daily basis, e.g. checking the forecast accuracy of the model

statistically

y

g

(14)

Market risk modelling – Part a

Overview of significant recent regulatory guidance



Modification of the qualitative/quantitative criteria for

internal models

July 2008 – First Consultation January 2009 – Second Consultation

g

y g



Stressed VaR



Standardized specific risk for equity positions



Prudent valuation - illiquid positions



IRC

All price risks



Standardized specific risk for equity positions



Securitisation treatment



Additional disclosures

All price risks

3 different floors for the liquidity horizon

Default and migration by 1 January 2010

All price risks by 1 January 2011



Additional disclosures



IRC

Default and migration risks

1 floor of 3 months for the liq idit hori on

Exception for correlation trading activities ("Maximum

1 floor of 3 months for the liquidity horizon

31 December 2010

Announced in a June 2010 BCBS press release

July 2009 – Final documents February 2011 – Update

of..."; Comprehensive Risk Measure)

Initial deadline : 31 December 2010

Announced in a June 2010 BCBS press release

New deadline : 31 December 2011

Two-year transition period for the treatment of securitisation positions ("Maximum of...")

8 % floor for the CRM

Stress testing guidance for CRM

Provides clarifications to the revisions and IRC id li

July 2011 – Interpretative Issues

The path was paved out

For internal use only

Risk

26th_{October 2011} ₁₄

guidelines

(15)

Market risk modelling – Part a

Overview of significant recent regulatory guidance (cont’d)

Revised Market Risk Framework

g

y g

(

)

• Independently of the inclusion of the related positions in the VaR & SVaRIndependently of the inclusion of the related positions in the VaR & SVaR ** No adjustment for double counting with other risk measures

(16)

Market risk modelling – Part a

Overview of significant recent regulatory guidance (cont’d)

Regulatory

g

y g

(

)



All positions

ff

t d b

All Global Markets and Global Banking positions

All trading book positions

Regulatory

Changes

1 affected by

Stressed VaR…



…

AND

by

All trading book positions sensitive to credit

i

ti

d d f

lt i k

All trading book positions

1 Incremental Risk

Charge (IRC) …



…

OR

by

migration and default risk

Securitisation

products

Re-Securitisation

N-th to

default

2 Securitisation

charge…



OR

b

products

LSS*

Correlation Trading Portfolio

Hedges in

3

* LSS : Leveraged Super senior trades ** NTD : Nth-to-Default credit derivatives



…

OR

by

Comprehensive

Risk Model (CRM)

charge (s.t.floor)

CDO^2

g

(CTP)

correlation

books

NTD**

4 For internal use only

Risk

(17)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(18)

Market risk modelling – Part a

Changes to VaR



Qualitative & quantitative criteria

1



Risk factors

Internal Model Approach - Generalities

g



Risk factors

Factors deemed relevant in pricing function should be included in VaR model (otherwise justification to Supervisor)

Non-linearities for options and other relevant products (e.g. mortgage-backed securities, tranched exposures or n-th-to-default credit derivatives)

Correlation risk

Basis risk (e.g. between credit default swaps and bonds)

Proxies used should show a good track record for the actual position held (i.e. an equity index for a position in an individual stock)



Scaling methodology (e.g. square-root of time) for the holding period (1-day to 10-day) is allowed but must

be justified periodically to the supervisors



Use of weighting schemes is more flexible as long as the resulting capital requirements is not reduced



Update of data sets should be made, at least, on a monthly basis (process allows more frequent updates)



Hypothetical (or clean) backtesting is made mandatory for validation



Stress Testing (use of more recent examples for Stress testing scenarios)

1. CRD III requires in addition reverse stress testing

2 CRD III i i tit ti t l l t h ti i t tl th b i f h th ti l ( l ) d t l (di t ) b k t ti Th l f t i d t i d b th hi h f th

For internal use only

Risk

26th_{October 2011} ₁₈

24/10/2011

2. CRD III requires institutions to calculate overshootings consistently on the basis of hypothetical (clean) and actual (dirty) back-testing. The plus-factor is determined by the higher of the number of overshootings under hypothetical and actual changes in the value of the portfolio.]

(19)

Market risk modelling – Part a

Specific Risk



All material components of price risk must be captured



Surcharge models are no longer allowed

Internal Model Approach – Specific Risk



Surcharge models are no longer allowed



Specific risk of equity risk positions

Model event risk (e g merger break ups/takeovers) at 99% 10 day horizon

Model event risk (e.g. merger break-ups/takeovers) at 99%, 10 day horizon



For securitisation positions and n-th-to-default credit derivatives

Specific risk capital charge is based on the standardised method

Positions may be included in VaR but a standardised charge is required anyway

Limited exception for correlation trading portfolio

 Comprehensive Risk Measure

 Floor equivalent to 8 % of the standardised methodq



For traded debt instruments (interest rate risk positions)

(20)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 26

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

Conclusions & Q&A

- 39

For internal use only

Risk

(21)

Market risk modelling – Part b

Stressed VaR



Intended to replicate a value-at-risk calculation that would be generated on the bank’s current portfolio if the

relevant market factors were experiencing a period of stress

Internal Model Approach – New charges



Applied to all positions covered under VaR

- Consistent with the VaR (99%, 10 days) for the current portfolio



Model inputs calibrated to historical data

Continuous 12-month period of significant financial stressp g

Relevant to the bank’s portfolio

Approved by the supervisor

Regularly reviewed



No particular technique is prescribed for VaR

(i.e. parametric, historical or Monte Carlo); hence, different techniques might be used to deliver a SVaR

 For example, banks should consider applying anti-thetic data, or applying absolute rather than relative volatilities to deliver an appropriate stressed value-at-risk1



At least, a weekly calculation

Capital requirement

Expressed as :

 "sVaRavg"= average SVaR number over the last 60 business days (i.e. 12 results)

 Multipliers (mc and ms ) are set by supervisors, minimum 3 plus [0 - 1] depending on the backtesting results based on the VaR (not the SVaR)2

1. This is not specified in the CRD III

(22)

Market risk modelling – Part b

Incremental Risk Charge



Who?

Banks that model specific risk for traded debt instruments (interest rate risk positions)

If not met standardised method

g

If not met, standardised method

If met, default and migration risks could be excluded from VaR/SVaR to avoid double counting



What?

Default and migration risks

All positions subject to a capital charge for specific interest rate risk,BUT

Not securitisation positions nor n-th-to-default credit derivatives (even if hedges)

Subject to supervisory approval, all listed equity positions and derivatives positions based on listed equities, consistently with internal risk management framework

Not CRM hedges, if applicable



How?

No prescribed methodology

Soundness standards comparable to IRB (99,9 % ; 1 year)

C t t l l f i k ti

Constant level of risk assumption

Rebalancing positions thereby maintaining initial risk level (i.e. equivalent risk characteristics than original position)

Rebalancing frequency is driven by the liquidity horizon of a given position

Banks may assume a 1-year constant position, if applied consistently

For internal use only

Risk

26th_{October 2011} ₂₂

(23)

Market risk modelling – Part b

Incremental Risk Charge….Detailed guidelines



Soundness of standard

Comparable to that of the internal-ratings based approach for credit risk as set forth in this Framework (99,9%, 1 Year),

under the assumption of a constant level of risk

g

under the assumption of a constant level of risk,

and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging, and optionality



Constant level of risk

The constant level of risk assumption implies that a bank rebalances its trading positions over the one-year capital horizon in a

The constant level of risk assumption implies that a bank rebalances its trading positions over the one year capital horizon in a manner that maintains the initial risk level

This means incorporating the effect of replacing positions whose credit characteristics have improved or deteriorated over the liquidity horizon with “original” positions



S

d

f

d

d/C

l

l f i k



Soundness of standard/Constant level of risk

The frequency of the assumed rebalancing must be governed by the liquidity horizon

The liquidity horizon represents the time required to sell the position or to hedge all material risks covered by the IRC model in a stressed market

A bank can assess liquidity by position or on an aggregated basis (“buckets”)

A bank can assess liquidity by position or on an aggregated basis ( buckets )

The liquidity horizon for a position or set of positions has a floor of three months

The liquidity horizon is expected to be greater for positions that are concentrated

A non-investment-grade position is expected to have a longer assumed liquidity horizon than an investment-grade position.

A bank may elect to use a one-year constant position assumption

A bank may elect to use a one year constant position assumption



Correlation/Diversification/Concentration

A bank’s IRC model must include the impact of clustering of default and migration events (-> correlation/dependence within IRC)

Diversification between default or migration events and other market variables is not reflectedg

(24)

Market risk modelling – Part b

Incremental Risk Charge….Detailed guidelines (cont’d)



Modelling

Netting only allowed if long and short refer to the same financial instrument

Significant basis risks has to be captured

g

(

)

Significant basis risks has to be captured

Risk because of a maturity of the instrument shorter maturity than the liquidity horizon has to be captured

Residual risks resulting from dynamic hedging strategies must be reflected

Optionality must be captured



Validation

Model assumptions and inputs must be regularly validated (LH, CH, correlation, …)

Back testing will not be possible. Accordingly, validation of an IRC model necessarily must rely more heavily on indirect methods including but not limited to stress tests, sensitivity analyses and scenario analyses

Banks should develop relevant internal modelling benchmarks



Use test

Model assumptions and inputs must be regularly validated (LH, CH, correlation, …)

Back testing will not be possible. Accordingly, validation of an IRC model necessarily must rely more heavily on indirect methods

i l di b t t li it d t t t t iti it l d i l

including but not limited to stress tests, sensitivity analyses and scenario analyses

Banks should develop relevant internal modelling benchmarks



Diverging internal approaches

Demonstrate that the approach does not results in a lowered capital charge

CRD III foresees an annual review by competent authorities



Weekly Calculation



Capital requirement = Max [IRC

; IRC

] where IRC

equals the institution’s 12 weeks average measure of IRC

For internal use only

Risk

26th_{October 2011} ₂₄

24/10/2011



Capital requirement = Max. [IRC

_t-1

; IRC

_AVG

], where IRC

_AVG

equals the institution s 12 weeks average measure of IRC

(or 12 observations)

(25)

Market risk modelling – Part b

Comprehensive Risk Model



Who?

Banks that model specific risk for interest rate risk positions

Banks active in buying and selling correlation trading products

If not met, standardised method for correlation trading portfolio



What?

All price risks

All positions subject to the correlation trading portfolio definition

CDR III : including any positions that are jointly managed ( = hedges) with positions of the correlation trading portfolio -those positions are then excluded from IRC



How?

No prescribed methodology

Same principles as for IRC (99,9 % ; 1-year ; constant level of risk assumption ; adjusted for liquidity, concentrations, etc.)

Minimum risk coverage

Cumulative risk arising from multiple defaults, including the ordering of defaults, in tranched products.

Credit spread risk, including the gamma and cross-gamma effects

Volatility of implied correlations, including the cross effect between spreads and correlations.

Basis risk, including both the basis between:

th d f i d d th f it tit t i l

the spread of an index and those of its constituent single names

the implied correlation of an index and that of bespoke portfolios

Recovery rate volatility

To the extent the comprehensive risk measure incorporates benefits from dynamic hedging, the risk of hedge slippage and the potential costs of rebalancing such hedges

(26)

Market risk modelling – Part b

Comprehensive Risk Model – How? (cont’d)



Additional conditions

Sufficient market data (fully captures the salient risks of exposures)

Demonstrate (e g backtesting) appropriate explanation of the historical price

(

)

Demonstrate (e.g. backtesting) appropriate explanation of the historical price

variation of these products

Ensure positions separation between those positions subject to CRM approval

and other positions

Stress scenarios (cf. additional guidance introduced in February 2011 version)( g y )

Predefined scenarios

Scope : default rates, recovery rates, credit spreads, and correlations

At least, weekly run

At least, quarterly reporting to supervisors (possible capital add-ons)



Weekly calculation



Capital requirement

Max. [CRM_t-1; CRM_AVG], where CRM_AVGequals the institution’s 12 weeks

average measure of CRM (or 12 observations).

Floor = 8 % of standardised method for correlation trading portfolio

For internal use only

Risk

26th_{October 2011} ₂₆

(27)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(28)

Calculation of the capital requirements

Changes to the market risk capital algorithm



The Market Risk capital charge is defined as the highest of



Its previous day’s value-at-risk number (VaR

_t-1

) and



The average of the daily value at risk measures on each of the preceding sixty business days (VaR

) multiplied

Current Framework

g



The average of the daily value-at-risk measures on each of the preceding sixty business days (VaR

_avg

) multiplied

by a multiplication factor (m)



plus



The previous day’s Specific VaR component (VaR

_Spec,t-1

)





Upcoming Framework



t avg



Spec t MRTot MR Spec

Old

MR

VaR

m

VaR

c

_,



max

_₁

;

*



_, _₁



_,



_,

For internal use only

Risk

26th_{October 2011} ₂₈

(29)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(30)

Challenges ahead

Interpretative Vs Implementation Issues



Stressed VaR

“Anti-thetic” and “applying absolute rather than relative volatilities”?

Interpretative Implementation



Stressed VaR

Stress-period market data availability for new products / risk factors



IRC&CRM

Sovereign bonds to be included in the IRC? -> YES

Extend IRC to CRM for one single calculation?

Varying stress periods due to changes in the portfolio



IRC & CRM

Definition of regions and sectors g

One single integrated CRM model?

Assuming multivariate normal distributions or normal copula?

VaR specific risk necessary for CRM covered positions?

g

Relevance for bank portfolio vs. availability of data

Calculation of short term migration matrices

Continuous (generator matrix) vs. discrete (cohort method) time methods



Standardised Measurement Method

Netting, basis of assessment and Max-Loss principle

method) time methods

Instrument Valuation

Modelling positions maturing before the end of the liquidity horizon

IRC is a hypothetical risk measure, takes into



Other issues



Updates if and when additional interpretive issues

arise

C s a ypot et ca s easu e, ta es to

account only a limited number of RF and therefore explains only parts of the price variation



CRM

No industry standard

Model complexity

Identification of positions / treatment of hedges (->IRC)

For internal use only

Risk

26th_{October 2011} ₃₀

(31)

Challenges ahead

The relationship between banks and regulators

g

(32)

Challenges ahead

Approaching the deadline

g



A

d ?



Are we ready?

For internal use only

Risk

26th_{October 2011} ₃₂

(33)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(34)

Feedbacks from QIS

Review of Quantitative Impact Studies

TBG-QIS 2009:



“Excluding the so-called correlation trading portfolio, the study concludes that the changes to the market

risk framework will increase average trading book capital requirements by two to three times their current

levels, although the Committee noted significant dispersion around this average”

TBG-QIS 2009/2010: Adjustments to the Basel II market risk framework announced by the Basel Committee (18

June 2010):



“As a result of these revisions, market risk capital requirements will increase by an estimated average of

three to four times for large internationally active banks”

For internal use only

Risk

26th_{October 2011} ₃₄

(35)

Feedbacks from QIS

Review of Quantitative Impact Studies

Changes in risk-weighted assets

-

Table below presents the change in risk-weighted

assets attributable to the introduction of Basel III and

Changes in trading book-related capital charges

relative to current market risk requirements

assets attributable to the introduction of Basel III and

separated into the following items:

_-

_{Across the sample of 61 Group 1 banks providing data,}

the SvaR was on average 248.7% of the VaR provided

by firms for a non-stressed period, typically the period

ending 31 December 2006.

-

This ratio ranged from as low as 86.7% to a high of

814.9%, with a median of 207.2% and a standard

deviation of 141.7%.

-

Some additional summary statistics regarding the new

trading book capital requirements compared to current

Changes in risk-weighted assets in the trading book

-

Table below shows the impact of the revised trading

book capital charges on overall RWAs

-

SVaR results in an average increase in overall capital

trading book capital requirements compared to current

market risk capital requirements are included in the

table below

SVaR results in an average increase in overall capital

requirements of 2.6%. However, there is significant

dispersion of the increases across Group 1 banks with

a maximum of 51.8% for one bank in the sample

(36)

Feedbacks from QIS

Review of Quantitative Impact Studies

Changes in risk-weighted assets

-

Table below presents the change in risk-weighted

assets attributable to the introduction of Basel III and

Changes in trading book-related capital charges

relative to current market risk requirements

assets attributable to the introduction of Basel III and

separated into the following items:

_-

_{Across the sample of 61 Group 1 banks providing data,}

the SvaR was on average 248.7% of the VaR provided

by firms for a non-stressed period, typically the period

ending 31 December 2006.

-

This ratio ranged from as low as 86.7% to a high of

814.9%, with a median of 207.2% and a standard

deviation of 141.7%.

-

Some additional summary statistics regarding the new

trading book capital requirements compared to current

Changes in risk-weighted assets in the trading book

-

Table below shows the impact of the revised trading

book capital charges on overall RWAs

-

SVaR results in an average increase in overall capital

trading book capital requirements compared to current

market risk capital requirements are included in the

table below

SVaR results in an average increase in overall capital

requirements of 2.6%. However, there is significant

dispersion of the increases across Group 1 banks with

a maximum of 51.8% for one bank in the sample

For internal use only

Risk

26th_{October 2011} ₃₆

(37)

Agenda

Agenda Item

Topics discussed

Pages

Th d

l

t f

k t

-

Overview

-

Historic development of the regulation

M k t d

l

t

The development of a new market

risk framework

-

Market developments

-

The key driver: assessing the performance of the VaR

model and market risk measures during the financial

crisis

- From 4 to 16

Overview of significant recent regulatory guidance

Market risk modelling – Part a

-

Overview of significant recent regulatory guidance

-

Changes to VaR

-

Specific Risk

- From 18 to 19

Market risk modelling – Part b

-

Introduction of Stressed VaR

-

Incremental Risk Charge

- From 21 to 26

Market risk modelling Part b

Incremental Risk Charge

-

Comprehensive Risk Model

From 21 to 26

Calculation of the capital

requirements

-

Changes to the market risk capital algorithm

- 28

Challenges ahead

-

Interpretative Vs Implementation issues

-

The relationship between banks and regulators

-

Approaching the deadline

- From 30 to 32

Feedbacks from QIS

-

Review of Quantitative Impact Studies

- From 34 to 35

(38)

Conclusion - Q&A

Wrapping Up

g



New market risk framework as imperfect solution with a noble scope



Lacking intellectual consistency



“Citiboys” would have preferred a simpler solution



Potential damages for some trading activities



Weakening the importance of VaR for capital management purposes



Changing shape for risk management profession



Swelling costs for financial institutions

Any questions?

For internal use only

Risk

26th_{October 2011} ₃₈

(39)

Appendix 1 Metrics for calculating regulatory capital for market risk

The regulatory framework distinguishes between general and specific market risk:

Specific market risk relates to the idiosyncratic risk affecting exposures to individual issuers

General market risk relates to the systematic risk affecting the overall market

g

y

General Market Risk

Specific Market Risk

General market risk relates to the systematic risk affecting the overall market

The total market risk of a (portfolio of) position(s) is the sum of its idiosyncratic and systematic components

VaR

_G

+ S-VaR

_G

VaR

S

+ S-VaR

S

(equity

issuer and prepay risk)

“

Ordinary” Trading Book

Positions

VaR

_G

+ S-VaR

_G

VaR

_S

+ S-VaR

_S

+ IRC

“

Linear” Traded Credit

Products (CDS, Indices)

VaR

_G

+ S-VaR

_G

Market Risk Standard

Approach

Securitisation Positions and

N

th

_{-to-default Credit}

Derivatives

VaR

_G

+ S-VaR

_G

CRM

(40)

Appendix 2 Standardised Measurement Method



Specific risk: EQUITY

Preferential treatment for liquid equity positions removed

8% specific risk capital charge for all equity positions



Specific risk: (RE-) SECURITISATIONS

Standard risk weights according to banking book regulation

SFA, concentration measure or deduction for unrated positions

 Supervisory Formula Approach based on PDs and LGDs for all underlying exposures derived from IRBA or from IRC

Capital requirements for long and short positions

 Max (long, short) for a two year transition period



Specific risk: CORRELATION TRADING PORTFOLIO

Definition correlation trading portfolio

Max (long, short) on a permanent basis

For internal use only

Risk

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Appendix 2 - Securitisations

(42)

Appendix 2 The correlation trading portfolio

Standardised Measurement Method



Securitisations and n-th-to-defaults that meet the following criteria:



All reference entities are single-name products, including single-name credit derivatives, for which a liquid two-way

market exists. This will include commonly traded indices based on these reference entities

A two-way market is deemed to exist where there are independent bona fide offers to buy and sell so that a price

A two way market is deemed to exist where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at such price within a relatively short time conforming to trade custom



No resecuritisations and no derivatives of securitisation exposures that do not provide a pro-rata share in the

d

f

i i

i

h (

i

d LSS)

proceeds of a securitisation tranche (e.g. options and LSS)



Positions which reference an underlying that would be treated as a retail exposure, a residential mortgage

exposure or a commercial mortgage exposure under the stan-dardisedapproach to credit risk are not included in

the correlation trading portfolio Positions which reference a claim on a special purpose entity are not included

the correlation trading portfolio. Positions which reference a claim on a special purpose entity are not included

either



Hedges which are neither securitisation exposures nor n-th-to-default credit derivatives and where a liquid two-way

market as described above exists for the instrument or its underlyings may be included

For internal use only

Risk

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References

 The Turner Review: A regulatory response to the global banking crisis – (2009)

 Results of the comprehensive quantitative impact study. BCBS (2010)

 Revisions to the Basel II market risk framework. BCBS (2010)

 Fear drives rethink of value-at-risk models. (Dominic Elliott). Efinancial News (2010)

An empirical approach for determining the “stressed time window”. (Adolfo Montoro) Internal document. Deutsche Bank (2010)

Stress Value-at-Risk. (Adolfo Montoro) Internal document. Deutsche Bank (2010)

Stressed Value-at-Risk (SVaR) Overview. (Adolfo Montoro). Internal Document. Deutsche Bank (2010)

Stressed VAR questioned by risk managers..Mark Pengelly. Risk.net (2010)

Message from the academic literature on risk measurement for the trading book. BCBS (2011)

Comments to Consultative Document “Revisions to the Basel II market risk framework”. BCBS (2009)

Note on Stressed VaR. (Axel Kunde). Internal Document. Deutsche Bank

Regulatory developments and timeline for implementation – Mark Peters. Banque Nationale de Belgique

(44)

Bio

Adolfo Montoro FRM, is a Vice President within Deutsche Bank's Market Risk Management department in London

He currently heads up the Traded Market Risk Economic Capital Methodology team located in London as well as the

Risk Research & Development team in New York He has previously been part of the Value-at-Risk Methodology team

Risk Research & Development team in New York. He has previously been part of the Value-at-Risk Methodology team.

The teams insure the adequacy of quantitative methodologies used for market risk management and regulatory purposes

Prior to joining Deutsche Bank, he was a member of the Market Risk Control Department at UBS O’Connor in London.

O'Connor is a key strategic alternative investment provider within the A&Q platform of UBS Global Asset Management

y

g

p

g

Before transferring to the UK Adolfo worked as Market Risk Manager for the Front Office Market Risk team at Banca Del

Gottardo (now Banca della Svizzera Italiana BSI) in Lugano, Switzerland. He started his career in the Risk Management

Department at FinecoGroup in Milan, Italy

He has earned an MSc in Risk Management from Bocconi University, Italy, and graduated with a degree in economics

(with honors) from Universita' della Calabria, Italy. He has earned his Financial Risk Manager (FRM) certification in 2005

Adolfo is currently affiliated with the Global Association of Risk Professionals where he serves as Regional Director for

the UK Chapter

Adolfo can be contacted at

[email protected]

For internal use only

Risk

26th_{October 2011} ₄₄

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