1 enterprise risk management april26-27 chicago, illinois chief risk officer forum dr. robert m....

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Enterprise Risk ManagementApril26-27

Chicago, Illinois

Chief Risk Officer Forum

Dr. Robert M. MarkDr. Robert M. MarkCEOBlack Diamond Tel: 925 878 [email protected]

Black Diamond Risk Management 2

Dr. Robert M. MarkDr. Robert M. [email protected] 925 878 9943

l Dr. Robert M. Mark is the Chief Executive Officer of Black Diamond which provides corporate governance, risk management consulting and transaction services. He serves on several Boards such as the Fields Institute for Research in Mathematical Sciences, IBM’s Deep Computing Institute, Checkpoint Canada, The Royal Conservatory and is an Advisory Director on Entergy Koch’s Audit Committee of the Board . He also serves on Checkpoint’s Investment Committee. In 1998, he was awarded the Financial Risk Manager of the Year by the Global Association of Risk Professionals (GARP). He is the Chairperson of The Professional Risk Managers’ International Association’s (PRMIA) Blue Ribbon Panel

l Prior to his current position, he was the Senior Executive Vice-President and Chief Risk Officer (CRO) at the Canadian Imperial Bank of Commerce (CIBC). Dr. Mark was a member of the Management Committee. Dr. Mark’s global responsibility covered all credit, market and operating risks for all of CIBC as well as for its subsidiaries. Prior to his CRO position, he was the Corporate Treasurer at CIBC.

l Prior to CIBC, he was the partner in charge of the Financial Risk Management Consulting practice at Coopers & Lybrand(C&L). The Risk Management Practice and C&L advised clients on risk management issues and was directed toward financial institutions and multi-national corporations. This specialty area also coordinated the delivery of the firm’s accounting, tax, control, and litigation services to provide clients with integrated and comprehensive risk management solutions and opportunities.

l Prior to his position at C&L, he was a managing director in the Asia, Europe, and Capital Markets Group (AECM) at Chemical Bank. His responsibilities within AECM encompassed risk management, asset/liability management, research (quantitative analysis), strategic planning and analytical systems. He served on the Senior Credit Committee of the Bank. Before he joined Chemical Bank, he was a senior officer at Marine Midland Bank/Hong KongShanghaiBank (HKSB) where he headed the technical analysis trading group within the Capital Markets Sector.

l He earned his Ph.D., with a dissertation in options pricing, from New York University’s Graduate School of Engineering and Science, graduating first in his class. Subsequently, he received an Advanced Professional Certificate (APC) in accounting from NYU’s Stern Graduate School of Business, and is a graduate of the Harvard Business School Advanced Management Program. He is an Adjunct Professor and co-author of “Risk Management” (McGraw-Hill), published in October 2000. He also served on the board of ISDA as well as the Chairperson of the National Asset/Liability Management Association (NALMA).


A significant challenge for a CRO is to stay on top of a complex combination of factors which drive risk

CustomersInvestors

MarketsRegulatorsRating AgenciesEquity Analysts

PeopleCulture

IncentivesExperience

PeopleCulture

IncentivesExperience

Cre

dit R

isk

Market R

isk

Operations Risk

lThe ability to efficiently integrate all the components of risk as well as to effectively operate in markets while serving customers as well as satisfying regulatory requirements is a direct function of the quality of the people, the associated culture, as well as incentives and experience


POLICIES METHODOLOGIES

INFRASTRUCTURE

A significant challenge for a CRO is to build a proactive risk management function that can be benchmarked in terms of:


l The CPMG has become part of the landscape through which proactive risk management functions are actively managing their Credit Portfolio

POLICIES METHODOLOGIES

INFRASTRUCTURE

For example, a proactive risk management function would include building a Credit Portfolio Management Group (CPMG)

ProactiveRisk

Management


l Ongoing Policy Assessment from a CRO’s perspective involves asking several critical questions. These include:

l Is the tolerance for risk consistent with the Business Strategies?

l Do the risk authorities reflect a desired tolerance for risk?

l Is risk properly disclosed internally and externally?

Dis

clos

ure

Au

tho

rities

Risk

Tolerance

BusinessStrategies

IndependentFirst-Class

Proactive RiskManagement

Policies


l A Significant challenge for a CRO is to ensure that there is a formalized process to discuss and debate the tradeoffs amongst the various business units to opportunistically increase their risk.

l The tolerance for risk is ideally tied to a well articulated and transparent business model.

Strategy and Risk Tolerance

Dis

clos

ure

Au

tho

rities

Risk

ToleranceBusinessStrategies




Example 1: August 1998:

Equity prices dropped sharply

Equity Volatility increased

Liquidity dried up (Flight to quality)

Correlations broke down

Credit spreads widened

Credit quality deteriorated

WideCreditSpread

HighVolatility

LowLiquidity

August ‘98


Risk Authorities58mm

29mm

July 22

Oct 02

Nov97

Mar98

Jul98

Aug98

Oct98

Feb99

Jun99

Jul99

Aug99

Sep99

Oct99

A key challenge for CRO’s during Aug 1998 was to adjust the tolerance for risk in advance of extreme negative markets. For example:

VaR

38mm


l A test of best practice risk management is an organization’s ability to provide disclosure which makes the risk transparent to managers.

l Analytically rich disclosure is critical to a strong risk management process.

l Risks and financial flows should be well understood by managers and other stakeholders.

Dis

clos

ure

Au

tho

ribties

Risk

Tolerance

BusinessStrategies



Risk Disclosure


Certain types of disclosure have now become standard

Example 2: Daily Net Trading Revenue vs. Value at RiskC

$ M

illi

ons

ALCO Limit - Upper Boundary

ALCO Limit - Lower Boundary

Potential Predicted Positive Revenue

Daily Net Trading Revenue

Potential Negative RevenuePredicted

Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

August 27, 1998 August 27, 1998


l Ongoing assessment of methodologies involves such questions as:

l Is the design and implementation of VaR as well as stress testing methodologies appropriate?

l Are the mathematical models properly vetted?

l Are the positions properly valued?

l Are the risk methodologies tied into performance measurement?



Performance

Vetting Stress

Testing

VaR

There are many significant methodological challenges for a CRO


Positions Scenarios

TradingRulesInitial

PositionData

Change inPositionsHedging

DynamicAdjustments of

The Greeks

Positions Adjust

Over Time

P & L

Results

MarketMovementsOver Time

Horizon

ScenariosData

Volatility

Price PathImpact onLiquidity

}

Example 3: A key market risk challenge for a CRO is to realistically capture liquidity risk


l Ex: Credit Limit exposure for derivatives is typically measured through using a single Worst Case (W) or 2/3 W exposure and then combine it with credit risk limits in the banking book against the same obligor

Worst Case” Credit Worst Case Terminal Exposure (WT)

Cumulative Average Worst Case

(FE = 2/3 WT)

Expected Terminal ExposureIf W set at a 2 sigma = WT /5

Cumulative Average Expected Exposure

(=2/3 x WT /5)

Best Case (0) Time (T)

“Exposure path

“Expected” CreditExposure path

0 T

Example 4: A credit risk challenge for a CRO is to appropriately characterize credit risk in the trading book and integrate it with credit risk in the banking book


l Stressing the boundaries of credit risk

Credit risk factors may be shocked . . .

. . .To produce perturbations of combined distributions of

simulated future credit lossesEXPOSURE

DEFAULTS

RECOVERIESt 0

tN

0

TIMECREDIT LOSS

PR

OB

AB

ILIT

Y

Shocks

Correlations to other factors

Example 5: A key challenge for a CRO is to arrive at realistic reasonable paranoia stress tests?

EXAMPLE


Example 6: A key challenge for the CRO is to price market, credit and operational risk. For example, the credit risk for a Credit Derivative can be modeled as a put (utilizing a Merton Style “structural form” model)

l

l where P is the current value of the put, N(.) is the cumulative standard normal distribution, and

l and is the standard deviation of the rate of return of the firm’s assets.

)()( 201 dNFeVdNP rt -+--= -

TS

TFeV

TS

TrFVd

rT 22

10

22

10

1

)/ln()()/ln( ss +=

++=

-

Tdd s-=12


…and can be used to calculate expected credit spreads (CS). Liquidity is a key element that is difficult to incorporate

l Yield to maturity and credit spreads can be calculated according to well known technology:

l

[ -+-=-= - )]()(ln1

10

2 dNFe

VdN

Try rTTTcs

TF

PFe

TFB

y

rT

T

-

=-=

-

lnln 0

TrryTT -=cs


The market has reliable risk measures for The market has reliable risk measures for individual portfolios, but no highly reliable individual portfolios, but no highly reliable

measure for total risk across the trading book and measure for total risk across the trading book and banking book .banking book .

CROs have benefited from significant progress made in measuring market & credit risk and are now attacking Operational Risk…. but have not yet found a generally accepted Unified Risk Measure


l The implementation of best practice calls for methodologies that accurately value transactions and quantifies the return to risk relationships of the individual as well as portfolio of transactions.



Performance

Vetting &Valuation Stress Testing

VaR

Valuation and Performance


Infrastructure: Ongoing assessment of infrastructure involves such questions as:

Are the appropriate people and operating elements in place to control and report on risk? Are there periodic risk management change initiatives?

AccurateData

Operations

People(Skills)

IndependentFirst Class


Technology


Risk Management Change Initiative Questionnaire

QUESTION

What major themes underlie your business strategy as a whole?

Does this represent a major departure from the past? In what ways?

What are your three most critical deliverables this year? What are the most likely impediments to success?

Is there a single metric or set of metrics that is most important to you as your monitor progress against your goals?

COMMENTSCATEGORY

Self Description



CATEGORY QUESTION

How do you see the role of Risk Management changing in the context of your changing strategic Agenda?

How would this be different from the support you are currently receiving from Risk Management?

How do you believe Risk Management is doing in terms of meeting your regulatory/compliance requirements

Based on new/changing requirements, what do you feel we need to improve upon? Prepare for?

COMMENTS

Risk Management’s

Focus



CATEGORY

New

Requirements

No Longer

Required

QUESTION

Do you see Risk Management as a resource (problem solving)? How would you see that relationship playing out?

What are the values and principles that should guide Risk Management's relationship with its business partners?

Based on your new direction, what should RM be doing, that e are not currently doing, in terms of providing support to your business group?

Based on your business priorities, what should RM stop doing that adds any value?



CATEGORY QUESTION

What do you believe to be Risk Management's current strengths? What do we do well?

What do we need to do better?

Can you identify three issues/areas of concern, which you feel Risk Management adversely impacts on organizational effectiveness?

COMMENTS

GeneralAssessment

1 enterprise risk management april26-27 chicago, illinois chief risk officer forum dr. robert m....

Documents

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