abn amro futures ltd 1 counterparty due diligence craig macdougall head of credit abn amro futures...

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ABN AMRO Futures Ltd

Counterparty Due Diligence

Craig MacDougall

Head of Credit

ABN AMRO Futures Ltd. London

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ABN AMRO Futures Ltd

Subject MatterDue Diligence

• Why?• How?• How Far Do We Go?• What Questions To Ask?• Where to Look For Possible Problems?• How To Keep Up-To-Date• When To Review• Trends and Information Sources

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ABN AMRO Futures Ltd

'Don’t try to teach your grandma to suck eggs!'

Definition: - • Charles Earle Funk says in “Hog on Ice” (Harper & Row, New

York, 1948). “To teach one’s grandmother to suck eggs – To offer needless assistance; to waste one’s efforts upon futile matters; especially, to offer advice to an expert. This particular expression is well over two hundred years old; it is just a variation of an older theme that was absurd enough to appeal to the popular fancy. One of the earliest of these is given in Udall’s translation of ‘Apophthegmes (1542) from the works of Erasmus. It reads: ‘A swyne to teach Minerua, was a prouerbe, for which we sai: Englyshe to teach our dame to spyne.’” That last bit was about an expression, don’t try to teach a dame to spin.

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ABN AMRO Futures Ltd

COUNTERPARTY DUE DILIGENCE

WHY?

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ABN AMRO Futures Ltd

ANSWER:-

SCANDAL =

COUNTERPARTY DUE DILIGENCE - WHY?

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ABN AMRO Futures Ltd

Or even

COUNTERPARTY DUE DILIGENCE - WHY?

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ABN AMRO Futures Ltd

Banks slow to catch on to metals trading scam

- At least US$600M lost.

Non - Ferrous - Fabricated documents at centre of Allied Deals case, prosecutors say.

COUNTERPARTY DUE DILIGENCE - WHY?

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ABN AMRO Futures Ltd

17Feb2000 GHANA: Ashanti Goldfields reaches rescue deal as seven board members go.

COUNTERPARTY DUE DILIGENCE - WHY?

ENRON SCANDAL

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ABN AMRO Futures Ltd

In many ‘loss given default’ situations, lack of effective due

diligence can be a significant factor.

COUNTERPARTY DUE DILIGENCE - WHY?

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ABN AMRO Futures Ltd

How to KYC

• Client Visits.

• Financial Reports and Accounts.• Compliance, Legal Checks and MLRs.

• Market Knowledge and Developments.

• Stock price performance (KMV etc).

• The WEB.

• Regular Reviews.

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ABN AMRO Futures Ltd

How Far Should Due Diligence Go?

A. “As far as necessary to be comfortable!”

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ABN AMRO Futures Ltd

What are the vital questions?

A. Clearly this is dependent on the type of risk and the type of client...

• Do you know your customer?

• Does their business make sense?

• Can they support the risk?

• Is the legal documentation enforceable?

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ABN AMRO Futures Ltd

Client Visits (what to consider)

• Make real use of a client visit. Don’t just sit in the CFO’s office!

• Walk through systems.• Speak to staff. • Inspect & ask for copies of other bank or

broker facility documentation or get a letter of confirmation... don’t allow your firm to be ‘Dutch-auctioned’.

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ABN AMRO Futures Ltd

Client Visits (what to consider)

• Try to gain a good understanding of the client’s business.

• Do you feel that senior management are effecting good control?

• Discuss their risk management processes?

• How do they control Operational Risk?

• Do they have a DR Site? - really?

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ABN AMRO Futures Ltd

Client Visits (what to consider)

• Which VaR or DEaR method is used - historical simulation, parametric or Monte Carlo?

• Are the input variables sensible - confidence level, holding period, volatility, correlation, forward pricing?

• Are abnormal/tail event risks catered for?

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ABN AMRO Futures Ltd

Client Visits (what to consider)

• Are any other portfolio risk management methods used and do they make sense?

• Do risk controls extend to limits by region, product, tenor and basis?

• What stress testing is performed?

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ABN AMRO Futures Ltd

What Can Be Learned From Recent Events?

• Like price volatility, ratings downgrades can trigger huge calls…

• In the Californian power crisis last year some firms had margin calls of US$900mn in a single day, even when fully hedged!

• ...so how much risk capital and liquidity resources does the counterparty have?

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ABN AMRO Futures Ltd

Financial Reports and Accounts

• Analyse the financial position thoroughly. Request clarification of unusual items or notes. Look out for ‘dodgy deals’ e.g. round trip trades or granting options to raise premiums.

• Get bank and third party references if necessary.

• Get a feel for the management. What does your instinct tell you?

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ABN AMRO Futures Ltd

Financial Reports and Accounts

• FAS133; FAS141 & 142 re derivatives; goodwill, other intangibles and business combinations…

• ...serious impact on firms income and equity base for impairment or trading assets may be overstated.

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ABN AMRO Futures Ltd

What are the Compliance & Regulatory Implications?

A: Management has the responsibility to effect proper control over its business.

This means complying with regulatory requirements, company compliance rules and internal controls.

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ABN AMRO Futures Ltd

Market Knowledge and Developments

• Make contact with counterparts at other firms, not just at home but overseas too. Risk groups such as PRMIA and FOA are an ideal way to do this.

• Have a good channel of communication with traders.

• Get access to as many information sources as possible.

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ABN AMRO Futures Ltd

How often should you review?

A. Regularly... Ideally shortly after inception and then at regular intervals, at least annually. Again, may vary.

• Ensure accounts come through on time.

• Ensure covenants are met.

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ABN AMRO Futures Ltd

Future Trends?

• Credit due diligence is deepening and widening in scope in order for the bank or broker to know its customer.

• Some customers have prepared highly detailed information packs on relevant areas of their internal control processes.

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ABN AMRO Futures Ltd

Where can third party information be obtained from?

A. There are some very useful providers of free information and many that charge for their services. See the attached non-exhaustive list.

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ABN AMRO Futures Ltd

Third Party Information Websites

Moody’swww.moodysresearch.com/

Standard & Poor’swww.ratingsdirect.com/

FitchIbcawww.fitchibca.com/

Wright Investor Servicesprofiles.wisi.com/

Banker’s Almanacwww.bankersalmanac.com/

Financial Timesmarkets.ft.com/news/markets

Blombergwww.bloomberg.com

Reuters Business Brieffingwww.rbb.reuters.com/

Wall Street Journalonline.wsj.com/public/us

Bankscope Dun & Bradstreet Amadeus

Citywirewww.citywire.co.uk

efinancialnewswww.efinancialnews.com/

Italian Fund Management Datawww.assogestioni.it

Companies Housewww.companies-house.gov.uk/

Financial Services Authoritywww.fsa.gov.uk