beyond riskbeyond risk measurement: establishing a proactive risk management … · 2012. 8. 9. ·...

BEYOND RISKBEYOND RISK MEASUREMENT: ESTABLISHING A PROACTIVE RISK MANAGEMENT CULTURE

Presented by Claude Bergeron, Executive Vice-President and Chief Risk Officer Canadian Investment Review’s14th Annual Risk Management ConferenceAugust 23, 2012

022007-08 Crisis

01The Caisse

03Post Crisis

05What's Next?

04Risk Management Process

06What should you do

2

THE CAISSE

Mission

“The mission of the Caisse is

THE CAISSE

to receive moneys on deposit as provided by law and manage them with a view to achieving optimal return within the framework of depositors’ investment

li i hil t thpolicies while at the same time contributing to Québec’s economic development.”

4

More Than 46 Years of Investing

Founded in July 1965 by an Act of Québec’s National Assembly

THE CAISSE

Initial mandate to manage the assets of the Québec Pension Plan (RRQ)

Mandate broadened over the years to include funds deposited by other Québec public- and private-sector pension and insurance plans

25 depositors had net assets of $159.0 billion as at December 31, 2011

5

Main DepositorsQuébec public and private sector pension and insurance plans

As at December 31, 2011

$B %Government and Public Employees R ti t Pl (RREGOP)

42.0 26.4

THE CAISSE

Retirement Plan (RREGOP)

Retirement Plans Sinking Fund (RPSF) 36.4 22.9

Régie des rentes du Québec 34.9 21.9

Supplementary Pension Plan for Employees of the Québec Construction Industry

13.2 8.3

Commission de la santé et de la sécurité 9.9 6.3du travail

Société de l’assurance automobile du Québec

7.4 4.7

Pension Plan of Management Personnel (PPMP)

7.1 4.5

Other 8.1 5.0

6

Changes in Asset Allocation

2 41 3 160 Total net assets

(in billions of $)10 24 36 50 88 122

Asset allocation

THE CAISSE

100

77 71

79

66

17 19

13 28

28 27

25

14 12

8 12

27

22 24

5 9 8 5 5

3 2

5 4

2 5 4 7

9 12

5 10 4

4 Other

Infrastructure

Private Equity

Real Estate

Real Estate Debt

Gl b l E iti

Constant reduction of Fixed Income and increase in Equities and Alternative Investments

Early Private Equity (1971) and Real Estate (1980) investor

Diversification from Canadian Equities into Global Equities

66

53 54

38 36 34

1966 1970 1975 1980 1985 1990 1995 2000 2005 2011

Global Equities

Canadian Equities

Fixed Income

7

Geographic Breakdown

As at March 30, 2012

Geographic breakdown of total assets

THE CAISSE

15%

16%

26%

58%

E i

Europe

UnitedStates

Québec

Canada The Caisse has a significant Canadian and Québec bias

We are increasing our exposure to emerging markets

We currently have $2.6 billion invested in Brazil

0.1%

3.9%

7.1%

Other

Asia, Australia

Emerging markets

billion invested in Brazil and $2.1 billion in China, mostly in Equities and Real Estate

8

The Caisse in the Global ArenaDirect investments and partnership strategyAs at March 30, 2012

THE CAISSE

An investor active on five continents in all asset classes:42% of depositors’ total assets is invested outside Canada, mainly in industrialized countries7 1% of depositors’ total assets is invested in emerging markets including Brazil7.1% of depositors total assets is invested in emerging markets, including Brazil, India and China

A sought-after partner on global markets:Extensive global market in line with partnership strategyAccess to a large volume of major projects worldwide, particularly in real estate and private equity

9

Organizational Structure

As at December 31, 2011CHAIRMAN

BOARD OF DIRECTORS Human Resources Committee Governance and Ethics Committee

THE CAISSE

BOARD OF DIRECTORS Human Resources Committee Governance and Ethics Committee

Audit Committee Risk Management Committee

PRESIDENT AND CHIEF EXECUTIVE OFFICER Internal AuditManagement Committee

Depositors and Strategic Initiatives Investment Management Private Equity Real Estate

Risk

Finance

Fixed Income

Equity Markets

Ivanhoé Cambridge

Otéra Capital

Operations and Information Technology

Talent Management and Organizational Development

Legal Affairs and Secretariat

Public Affairs

Overlay Strategies

Economic Analysis and Asset Allocation Strategies

Hedge Fund of Funds

10

The Caisse vis-à-vis Its PeersA major institutional fund manager

One of the largest institutional fund managers in Canada and North America

THE CAISSE

One of the world’s 10 largest real estate asset managers

Leading Canadian private equity investor

Shareholder in more than 4,000 companies globally

One of the few North American entities with the highest credit ratings: AAA from DBRS and S&P, and Aaa from Moody’s

11

2007-08 CRISIS

2007

Context• Volatile equity markets• Rapid appreciation of the Canadian dollar

2007-08 CRISIS

p pp• Global credit crunch• Liquidity crisis in Canada’s third-party asset-backed commercial paper market

$12.6 billion of ABCP reclassified as non-liquid assets

$1.9 billion (15%) unrealized decrease in value of ABCP l d th C i ’ ll t f 2007 b 1 3%lowered the Caisse’s overall return for 2007 by -1.3%

13

2008

Context• The subprime mortgage debacle of 2007 set off a chain reaction that led to the

events of fall 2008

2007-08 CRISIS

• The investment bank Lehman Brothers declared bankruptcy• A sudden increase in risk aversion caused credit spreads to widen to an

extraordinary degree• As market volatility soared, financial institutions responded swiftly by cutting off

credit to preserve their liquidity• The value of the Canadian dollar fell sharply• With such extreme events, asset class correlation increased dramatically and

reduced the diversification effect

Caisse’s overall return: -25% versus -18.5% for the benchmark and a loss of $10.2 billion relative to the

benchmark

14

Lessons Learned

Stay away from complex derivatives and structured productsAll products must be well understood and integrated into all systems

2007-08 CRISIS

systemsNo portfolio manager or investment can be above the risk management processTransparency: portfolios, investments and risks are reviewed at all levels of the organizationA robust new product process is essentialA centralized risk management function ensures an integrated view of all risksThe risk management team should be part of the investment process and should monitor the risks associated with the Caisse’s portfoliosThe compensation program should reward risk-return balance in decision making

15

POST CRISIS

A Plan to Enhance the Caisse’s Risk Management

The ABCP episode and the 2008 financial crisis prompted the Caisse to strengthen its risk management capabilities

POST CRISIS

the Caisse to strengthen its risk management capabilities

1. Enhance the Caisse’s risk management culture• Business Unit Risk Managers (BURMs)• Review the mandate and composition of internal risk committees

2. Upgrade stress testing practices3. Strengthen the new product approval process4. Increase resources dedicated to risk management

• Double the head count• Invest in risk systems

5. Review risk methodologies

17

Review Risk Methodologies

D il l l ti f k t V R ith 99% l l f fid

POST CRISIS

Daily calculation of market VaR with a 99% level of confidence

Liquidity risk calculation methodology

Implementation of credit VaR

Counterparty risk

C t t i k l l ti th d lCounterparty risk calculation methodology

Credit ratings for countries and sovereign entities

18

Market Risk Methodology

General approach to market risk measurement• Historical 99% daily VaR computed from a sample of 1,500 days• Computed and published daily for public markets, monthly for private markets and the aggregate portfolio

POST CRISIS

portfolio• Reported numbers are annualized

Public markets• For public equities, each individual stock’s historical return series is its own risk factor• For fixed-income products, interest rate curves are built in-house and used as risk factors• For optional instruments, historical volatility surfaces are used in our modelling

Private markets• We use public proxies for real estate (REITs) and private equity investments• Each investment is assigned a specific set of proxies• The series are adjusted to take into account the leverage of the proxies and the actual investment, but also liquidity and diversification effects

• For infrastructure investments, we are working on an approach based on the risk factors tied to the valuation of a given investment rather than the proxy-based approach

19

Review of Processes and Changes in Governance

Review investment policies

POST CRISIS

Implement oversight for new investment activities

Adjust the portfolio managers’ incentive compensation process and the strategic planning process

Ensure investment and portfolio transparency with the risk-return report and presentations to the Risk Management Committee and the Executive Committee

Reorganize teams and enhance analytical capability

Involve the risk team in hedging and investment monitoring

20

Risk Reduction

Reduce active market risk by 56%

POST CRISIS

Reduce ABTN market risk by 54%

Reduce absolute market risk by 10%

Reduce credit and counterparty risk

Reduce liquidity risk with term funding

Reduce leverage from 36% to 17% (2008-2010)

21

RISK MANAGEMENT PROCESS

Transparently ensure a risk-return balance for the Caisse by assuminga second level of control, by employing effective risk management

Risk Management Model


tools and providing support with investment strategy development,while promoting a sound risk culture within the organization

Integrate risk managers

Incorporate risk component into our processes

Develop effective analysis tools

Strategies

23

Asset allocation

Overview of Risk Management Model

Fixed Income

Equity Markets

Private Equity

Real Estate

Business Unit Risk Managers

(BURMs)


Market risk analysis, stress testing and concentrations

Credit, counterparty and liquidity risk management

Data management

Risk management intelligence and policies

Activities associated with

quantitative measurement and analysis

Risk management intelligence and policies

Geopolitical risk analysis

Operational risk management

Activities associated with

qualitative analysis

24

Focus of Our Strategy

Knowledge and challenge

• In-depth knowledge encompassing investments, the portfolio and interrelated investments

• Constructive discussions on strategies and


challenge

Guidance and discipline

Co st uct e d scuss o s o st ateg es a dopportunities

• Define policies that reflect the risk management philosophy

• Establish clear, shared risk management processes• Develop structured and shared investment

processes

Development of effective analytical

tools

• Develop quantitative and qualitative tools• Ensure communications are complete yet

synthesized and straightforward

25

Basic Enterprise Risk Management (ERM) Process

•Decide on the acceptable level of riskD l d

•Anticipate major risks•Prioritize risksM it t ti l i k

1. Identify3. Mitigate


•Develop and implement a mitigation plan

•Monitor potential risksDialogue:

Market update, rebalancing

committee and risk-return

report

•Measure risks using systematic tools, e.g. VaR, stress tests, concentrations and indicators

•Analyze risks using quantitative and qualitative methods

2. Assess

26

Response to Risk Is Modulated

Impact of risk on the CaisseIllustrative probability distribution


"Major" risk "Usual" risk

Potential event characterized by:•Major impact

Potential risk characterized by:•Significant but less critical impact

•Generally low frequency•Typically not central to investment strategies

•Dialogue intended to mitigate risk

•Higher frequency•Deliberately accepted to generate returns

•Dialogue intended to optimize risk-return ratio

27

Prospective Risk Monitoring ProcessStep Activities

1. Risk detection(ongoing)

• Business experts monitor the portfolios and the basic indicators in consultation with the teams of portfolio managers

• Risk experts monitor transversal risks, e.g. Caisse concentrations, liquidity and counterparty

• Members of the risk management team monitor the markets


2. Prioritization of major risks(~ weekly)

• The Risk Management Committee conducts a roundtable discussion to address emerging risks and prioritize major risks–First item on the agenda of each committee meeting–Input from business experts and risk experts–Updating of the mapping of prospective risks–Designation of an officer for each major risk

3. Monitoring of major risks(ongoing)

• The risk officers monitor each major risk and its specific indicators

• The officers play a monitoring role, tracking risk development–Communication to the portfolio managers, senior management

d h B d f Di d dand the Board of Directors, as needed

4. Accountability (monthly)

• Accountability with the risk-return report–Prospective risks included in the Caisse report–Basic indicators included in the portfolio-based reports

28

Synthesize: Risk-Return Scorecard

Market risk indicators


Return indicators

Indicators for credit, counterparty, operational and main concentration

Main prospective risks

risks

29

Simplify

Appendices co er the indi id al risks in


• Appendices cover the individual risks in greater detail and are consulted as needed

• The analysis presents the issues succinctly and simply

• Tables and charts illustrate the status of the risk and its developmentthe risk and its development

30

Communicate: Risk-Return Reports

•The reports are discussed at meetings of the Board’s risk management


of the Board’s risk management committees

•In several pages, they summarize the Caisse’s various risks and the actions taken

•The appendices provide more detailed information as neededinformation as needed

•Twice a year, specific reports for each specialized portfolio facilitate in-depth discussion of risks incurred

31

The Caisse’s ERM has two components

Enterprise Risk Management (ERM) at the Caisse is a disciplined process designed to promote integrated management of its major risks


Operational componentAccountability to the Operational Risk Committee

*

Fi i lCommittee Financial componentAccountability to the Investment-Risk Committee

*Strategic risk is handled by the Management Committee

32

Basic Principles of the Financial Component of the Caisse’s ERM


1.Aggregate and consolidate knowledge and insight available internally and externally

2.Develop a forward-looking (e.g. anticipation of the next crisis) and in-depth approach (e.g. use of quantitative and qualitative methods) to major risks

3.Identify transversal risks in the portfolios (liquid and illiquid)

4.Prioritize efforts to address major risks

33

Basic Principles of the Operational Component of the Caisse’s ERM

1.Identify and assess the major operational risks using a self-


assessment process

2.Determine an owner for each major risk

3.Identify mitigation measures

4.Monitor risk indicators and internal and external incidents

5.Follow up on major risks, indicators and incidents with the Operational Risk Committee

34

WHAT’S NEXT?

Portfolio Risk Management: Our Toolkit Enables Us to Cover the Different Angles

Funding-liquidity issues• Funding-liquidity risk monitoring • Funding-liquidity stress testing

I l i f f di li idit i t i t i

Excessive concentrations• Concentration risk monitoring• Counterparty risk monitoring (including potential

f t )

WHAT'S NEXT?

• Inclusion of funding-liquidity impact in asset mix scenarios

future exposure)• Credit VaR (both active and absolute)

Excessive volatility• Historical market VaR (both relative and

absolute)• Stress testing (both relative and absolute)

Embedded correlation effects• Risk-factor decomposition• Concentration risk monitoring along several

axes using both VaR and exposure• Market-regime decomposition, including

extraction of correlation structures for eachextraction of correlation structures for each regime

Non-linear effects• Stress testing and sensitivity analysis• Inclusion of historical volatility surfaces in

market risk measures

36

Risk Management in the Context of Absolute ReturnWHAT’S NEXT?

Identification and analysis of important risks and the support to the managers are central to the risk management strategy

Risk management related to investments

For the Caisse’s overall portfolioRedefine the risk appetite from active risk to absolute risk metricsIdentify all concentrations by issuer, industry and country or risk factors that may affect the overall performanceReview risk appetite for concentration level and emerging marketsD l t t ti f th t ti l ti d l tilitDevelop stress testing for the concentrations, correlations and volatilityPut in place a market intelligence process to identify and monitor major risksConduct stress testing related to major risks to support decision making

37

Risk Management in the Context of Absolute Return

Risk management related to investments…

A well defined investment process that integrates the risk management team

WHAT’S NEXT?

A well-defined investment process that integrates the risk management team through the leadership of the BURMs

Identifying major risks that could lead to a permanent capital lossChallenging the project’s underlying assumptionsSimulating the impact of risk factors on the project’s expected return

For portfoliosProduce a risk heat mapExecute market intelligence for major risksConduct sensitivity analyses and stress testsConduct sensitivity analyses and stress tests

38

Other RisksWHAT’S NEXT?

Maintain the current process

Liquidity riskMonitor liquidity risk daily with stress testingDefine the minimum holding in liquid assets

Credit and counterparty riskMonitor and analyze credit riskMonitor and analyze credit risk by counterparty, clearing broker and clearing house

Operational riskIdentify and mitigate major operational risksDevelop operational incident gatheringEstablish and monitor key risk indicators

39

WHAT SHOULD YOU DO

Developed your risk culture

Someone should be responsible for risk management

WHAT SHOULD YOU DO

Someone should be responsible for risk management

Define your risk appetite

Put in place an ERM process adapted to your organizationA structured processKnowledge of all risks taken Transparency : Risks are reviewed and are weighted

41

Know Your RiskWHAT SHOULD YOU DO

Identify your top risks

Where to look:

Your liquidity risk, the deadliest risk

Your highest concentrations that can generate huge loss

Your key risk factors where are your biggest risk expositionsy y gg p

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beyond riskbeyond risk measurement: establishing a proactive risk management … · 2012. 8. 9. ·...

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