core - closeout risk evaluation october/2012 classification of information (check with an x):...
TRANSCRIPT
CORE - CloseOut Risk Evaluation
October/2012
CLASSIFICATION OF INFORMATION (CHECK WITH AN “X”):
CONFIDENTIAL AND RESTRICTED CONFIDENTIAL INTERNAL USE PUBLICX
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
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RISK MODELING IN MULTI-ASSET CLASS CLEARINGHOUSES
DEFINING A ROBUST & EFFICIENT RISK MODEL
NEED TO BUILD A RISK MODEL THAT REFLECTS, IN A REALISTIC WAY, THE RISK MANAGEMENT PROBLEM FACED BY A CLEARINGHOUSE
MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
OPPORTUNITY TO INCREASE EFFICIENCY VIARISK-OFFSETTING
BUT HOW TO ENSURE THAT EFFICIENCY GAINSARE ROBUST?
Efficiency gains are not considered robust when the assumptions employed by the risk-offsetting model have a low level of adherence to reality, resulting in insufficient resources for the clearinghouse to fulfill its obligations
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THE RISK MANAGEMENT PROBLEM FACED BY A CLEARINGHOUSE
IN THE EVENT OF A PARTICIPANT DEFAULT, THE RISK MANAGEMENT PROBLEM OF FACED BY A CLEARINGHOUSE IS TO HAVE THE RESOURCES AND LIQUIDITY NEEDED TO PROVIDE AN ORDERLY CLOSEOUT FOR THE SET OF POSITIONS HELD BY THE
PARTICIPANT, UNDER CURRENT MARKET CONDITIONS, CONSIDERING A MINIMUM HOLDING PERIOD
T+0 T+1 T+2 T+3 T+4 T+N...
PORTFOLIO CLOSEOUT PROCESS
MAJOR ASPECTS THAT SHOULD BE TAKEN INTO ACCOUNT BY THE MODEL
EVOLUTION (INTERTEMPORAL DYNAMICS) OF THE RISK FACTORS THAT DEFINE THE VALUE OF THE ASSETS AND CONTRACTS INCLUDED IN THE
PORTFOLIO, AS WELL AS OF THE PORTFOLIO COMPOSITION ITSELF
FRICTIONS, RESTRICTIONS AND OPERATIONAL FEATURES ASSOCIATED WITH EACH ASSET INCLUDED IN THE PORTFOLIO
TRADING MODEL – ELECTRONIC VS OTC
LIQUIDITY/MARKET DEPTH
POSSIBILITY OF A FRACTIONAL SETTLEMENT
SETTLEMENT MODEL – RTGS VS DNS
CASH FLOW STRUCTURE OF THE ASSET
RISK MODELING IN MULTI-ASSET CLASS CLEARINGHOUSES
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A MORE COMPLEX APPROACH THAN THAT OF MODELS BASED ON VAR
WHEN MODELLING THE RISK MANAGEMENT PROBLEM FACED BY A CLEARINGHOUSE, ONE MUST CONSIDER, IN A JOINT FASHION, THE EVOLUTION OF THE MARKET VARIABLES (PRICES & RATES) AND THAT OF THE PORTFOLIO
COMPOSITION, RESPECTING A SET OF SIGNIFICANT RESTRICTIONS IMPOSED BY THE CHARACTERISTICS OF EACH ASSET UNDER CONSIDERATION
PORTFOLIO CLOSEOUT RISK
T+0 T+1 T+2 T+3 T+4 T+N... DYNAMIC PROCESS WITH FRICTIONS
P&L CALCULATION
THIS TYPE OF MODELLING REQUIRES CONCEPTS AND TOOLS MORE COMPLEX THAN THOSE TYPICALLY EMPLOYED BY THE FINANCIAL INDUSTRY (I.E. MODELS BASED ON VAR). IN FACT, THESE MODELS OFTEN FOCUS ON
MEASURING THE POTENTIAL VALUE OF A STATIC PORTFOLIO, WITHOUT TAKING INTO ACCOUNT A DYNAMIC CLOSEOUT PROCESS WITH FRICTIONS
VARIATION RISK OF THE PORTFOLIO
VALUET+0 T+N
P&L CALCULATION
STATIC PROCESS WITHOUT FRICTIONS
RISK MODELING IN MULTI-ASSET CLASS CLEARINGHOUSES
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A MORE COMPLEX APPROACH THAN THAT OF MODELS BASED ON VAR (CONT’D)
ALTHOUGH THE MODELS BASED ON VAR MAY BE ADAPTED TO ESTIMATE THE CLOSEOUT RISK, THEIR PLAUSIBILITY IS COMPROMISED WHEN MULTI-ASSET AND MULTIMARKET PORTFOLIOS (I.E. HIGHLY HETEROGENEOUS) ARE
CONSIDERED
IMPLICIT CLOSEOUT MODEL
T+0 T+N
UNDERLYING HYPOTHESIS: ALL ASSETS & CONTRACTS ARE TO BE SETTLED AT THE SAME TIME WITHOUT ANY FRICTIONS, WITH FULLY COINCIDING CASH FLOWS
AN ALTERNATIVE APPROACH CONSISTS IN THE USE OF A MODEL BASED ON MULTIPLE SILOS, WHERE EACH SILO CONTAINS ONLY ASSETS AND/OR CONTRACTS WITH COMMON FEATURES (I.E. HOMOGENEOUS). IN THIS CASE, THE
TOTAL PORTFOLIO RISK IS GIVEN BY THE ALGEBRAIC SUM OF EACH SILO.
IMPLICIT CLOSEOUT MODEL
T+0 T+N
SUM OF RISKS
T+0 T+N T+0 T+N
SILO 1 SILO 2 SILO 3 ...
RISK MODELING IN MULTI-ASSET CLASS CLEARINGHOUSES
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SILO MODELLING & SYSTEMIC RISK INCREASE
SILO 1 SILO 2
EVEN A MODEL BASED ON SILOS, WITH SUPERCOLLATERALIZATION VIA SUM OF RISKS, DOES NOT NECESSARILY ENSURE A MORE ROBUST SYSTEM. IN FACT, A MODEL BASED ON SILOS MAY HIDE IMPORTANT RISKS OF LIQUIDITY FRAGMENTATION AND REDUCE INCENTIVES TOWARDS THE ADOPTION OF A DILIGENT BEHAVIOR IN TIMES OF CRISIS.
ORIGINAL SITUATION,
AGENTS “A” & “B”T+0 T+N
COLLATERAL (RISK) = 100
SILO 1
AGENT “A” HEDGES SILO 2 RISK ON THE
MARKETT+0 T+N T+0 T+N
SILO 1 SILO 2
AGENT “B” DOES NOT HEDGE AT ALL
T+0 T+N T+0 T+N
INCREASED MARKET VOLATILITY
COLLATERAL(RISK) = 200
COLLATERAL (RISK) = 100
T+0 T+N
SILO 2
DISINCENTIVE TOWARDS A DILIGENT BEHAVIOR
LIQUIDITY RISK INCREASES IN THE SYSTEM
LTCM SCENARIOS (1998) & NTN-D CRISIS (2002)
RISK MODELING IN MULTI-ASSET CLASS CLEARINGHOUSES
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
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THE CORE MODEL FOR RISK CALCULATION
THE CORE MODEL
THE CORE MODEL WAS SPECIFICALLY DEVELOPED BY BM&FBOVESPA TO ALLOW FOR ROBUST AND EFFICIENT RISK ESTIMATION IN A MULTI-ASSET CLASS, MULTIMARKET CLEARINGHOUSE
MAJOR FEATURES
CONSIDERS THE INTERTEMPORAL DYNAMICS OF THE PORTFOLIO CLOSEOUT PROCESS
CONTEMPLATES IMPORTANT FRICTIONS & RESTRICTIONS ASSOCIATED WITH THE SETTLEMENT PROCESS OF ASSETS AND CONTRACTS – TRADING DYNAMICS, MARKET LIQUIDITY AND DEPTH, CASH
FLOW STRUCTURE, ETC
ESTIMATES, IN BOTH A JOINT AND A CONSISTENT MANNER, THE MARKET AND LIQUIDITY RISKS ASSOCIATED WITH A PORTFOLIO CLOSEOUT PROCESS
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OVERVIEW: CLOSEOUT RISK CALCULATION IN THREE STEPS
1. DETERMINING THE CLOSEOUT
STRATEGYT+0 T+1 T+2 T+3 T+4 T+N...
Defines the portfolio closeout strategy which, respecting the settlement restrictions of the portfolio of assets/markets, should minimize the risk of a loss associated with the closeout process, preserving existing hedge strategies
2. RISK EVALUATION
T+0 T+1 T+2 T+3 T+4 T+N...
Defines the (stress) scenarios associated with the dynamics of each risk factor relevant to the portfolio. All assets and contracts are reevaluated considering the scenarios defined in this step (full valuation).
3. POTENTIAL P&L CALCULATION
T+0 T+1 T+2 T+3 T+4 T+N...
Calculates and aggregates intertemporally P&L associated with each scenario, considering the defined closeout strategy
CLOSEOUT RISK Result: Two risk measures—market and liquidity—that are estimated both jointly and consistently
PERMANENT LOSS TRANSIENT LOSS
THE CORE MODEL FOR RISK CALCULATION
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OVERVIEW: PERMANENT & TRANSIENT LOSS
T+0 T+1 T+2 T+3 T+4 T+N...
3. POTENTIAL P&L DETERMINATION
CASH NEED BY T+N
PERMANENT LOSS
V0 + V1 + V2 + V3 + V4 + ...
VN
V0
V0 + V1
V0 + V1 + V2
V0 + V1 + V2 + V3
V0 + V1 + V2 + V3 + V4
V0 + V1 + V2 + V3 + V4 + ...
VN
CASH NEED BY T+4
CASH NEED BY T+3
CASH NEED BY T+2
CASH NEED BY T+1
CASH NEED BY T+0
CASH
FLO
W A
MO
UN
TS
CASH NEED ON T+N
MAX
IMU
M B
ETW
EEN
TRANSIENT LOSS
EQUALS
THE CORE MODEL FOR RISK CALCULATION
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T+0 T+1 T+2 T+3 T+4 T+5
RIS
K
ITERATION
NAIVE STRATEGY1
OPTIMAL STRATEGY DEFINITION2
OPTIMAL STRATEGY3
CLOSEOUTPORTFOLIO
DETAIL: CLOSEOUT STRATEGY DEFINITION
FUTURES, BUY, IMMEDIATE SETTLEMENT
OPTIONS, SELL, SETTLEMENT ON T+3 ONLY
SWAP, SELL, SETTLEMENT ON T+5 ONLY
MINIMUM RISK
THE CORE MODEL FOR RISK CALCULATION
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T+1
CLOSEOUTPORTFOLIO
T+0 T+2
DETAIL: PORTFOLIO COMPOSITION & RISK FACTOR EVOLUTION
T+3 T+4 T+5 T+6
T+1T+0 T+2 T+3 T+4 T+5 T+6
RISK FACTOR EVOLUTIONMARKET
FACTOR 1
FACTOR 2
FACTOR n
P&
L A
LO
NG
TH
E P
RO
CE
SS
THE CORE MODEL FOR RISK CALCULATION
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DETAIL: RISK FACTOR EVOLUTION & MULTIVARIATE SCENARIO GENERATION
T+0 – T+1 – T+2- ... – T+N
...
FACTOR 1
FACTOR 2
FACTOR n
T+0 – T+1 – T+2 – ... – T+N
# S
CE
NA
RIO
RISK F
ACTOR
... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
MULTIVARIATE
SCENARIO
GENERATOR
T+0 – T+1 – T+2- ... – T+N
FACTOR 1
FACTOR 2
FACTOR n
... ... ... ... ......... ... ... ......... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
... ... ... ......
SCENARIOS TO DETERMINE P&L DURING THE CLOSEOUT PROCESS
THE CORE MODEL FOR RISK CALCULATION
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DETAIL: P&L DETERMINATION DURING THE CLOSEOUT PROCESS
T+1 T+2 T+3 T+4 T+5 T+6SCENARIOS POSITIVE FLOW
NEGATIVE FLOW
PERMANENT LOSS
TRANSIENT LOSS
PERMANENT LOSS
TRANSIENT LOSS
PERMANENT LOSS
TRANSIENT LOSS
PERMANENT LOSS
TRANSIENT LOSS
... ... ... ... ... WO
RS
T C
AS
E S
CE
NA
RIO
#1
#2
#3
#nSCN
THE CORE MODEL FOR RISK CALCULATION
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
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HEDGING STRATEGIES BENEFITING FROM THE CORE MODEL
MAIN EXAMPLES
HEDGING AN OTC DERIVATIVES POSITION ON THE LISTED DERIVATIVES MARKET
CORE RISK
T+0 T+1 T+2 T+3 T+4 T+N...
CURRENT MODEL
T+0 T+T T+0 T+T T+0 T+N
SILO 1
OTC POSITION
SILO 2
LISTED DERIVATIVESSILO 3
COLLATERAL
SUM OF RISKS
CLOSEOUT RISK
CORE RISK: PORTFOLIO CLOSEOUT COST (POSITIONS + COLLATERAL) MUST BE EQUAL TO OR LESS THAN ZERO
CURRENT MODEL: COLLATERAL-HAIRCUT EQUAL TO OR GREATER THAN RISK (OTC) + RISK (LISTED DERIVATIVES)
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HEDGING STRATEGIES BENEFITING FROM THE CORE MODEL
MAIN EXAMPLES (CONT’D)
ASSET BEING HEDGED IS POSTED AS COLLATERAL
CORE RISK
T+0 T+1 T+2 T+3 T+4 T+N...
CURRENT MODEL
T+0 T+T T+0 T+N
SILO 1
LISTED DERIVATIVES
SILO 2
COLLATERAL
SUM OF RISKS
CLOSEOUT RISK
CORE RISK: PORTFOLIO CLOSEOUT COST (POSITIONS + COLLATERAL) MUST BE EQUAL TO OR LESS THAN ZERO
CURRENT MODEL: COLLATERAL-HAIRCUT EQUAL TO OR GREATER THAN RISK (LISTED DERIVATIVES)
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HEDGING STRATEGIES BENEFITING FROM THE CORE MODEL
MAIN EXAMPLES (CONT’D)
EQUITIES BORROWER HOLDING COLLATERAL IN SHARES OF THE SAME COMPANY, BUT OF A DIFFERENT TYPE(PREFERRED VS COMMON)
CORE RISK
T+0 T+1 T+2 T+3 T+4 T+N...
CURRENT MODEL
T+0 T+T T+0 T+N
SILO 1
EQUITIES LENDING
SILO 2
COLLATERAL
SUM OF RISKS
CLOSEOUT RISK
CORE RISK: PORTFOLIO CLOSEOUT COST (POSITIONS + COLLATERAL) MUST BE EQUAL TO OR LESS THAN ZERO
CURRENT MODEL: COLLATERAL-HAIRCUT EQUAL TO OR GREATER THAN RISK (LENDING)
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
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CORE MODEL IMPLEMENTATION
MODEL COMPONENTS & IT ARCHITECTURE
OPTIMAL CLOSEOUT STRATEGY DEFINITION
PRICE GENERATION BASED ON MULTIVARIATE SCENARIOS
RISK AGGREGATION &CONTROL
INTERFACE WITH THE RTC PLATFORM (CINNOBER)
SPECIFIC SOFTWARE TO DEAL WITH OPTIMIZATION ISSUES
VERY HIGH PERFORMANCE PARALLEL ARCHITECTURE USING GRAPHIC UNITS WITH MULTIPLE PROCESSORS (GPUs)
HIGH PERFORMANCE SOFTWARE DEVELOPED IN C++ BY BM&FBOVESPA
RISK PLUG-IN DEVELOPED BY BM&FBOVESPA IN TANDEM WITH CINNOBER
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MODEL DEFINITION, PROTOTYPE
CONSTRUCTION, DEFINITIVE MODEL
TESTING
CORE MODEL DEVELOPMENT
INDEPENDENT ASSESMENT, FEASIBILITY ANALYSIS, SUPPORT TO MODEL
DEFINITION
CORE MODEL IMPLEMENTATION
TEAMS INVOLVED
RISK MANAGEMENT
OFFICE
FINANCE CONCEPTS (MR.
MARCO AVELLANEDA/NYU
& MR. RAMA CONT/COLUMBIA)
IT OFFICEPOST-TRADING
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CORE MODEL IMPLEMENTATION
PROJECT STATUS - MACRO
PROTOTYPE PRESENTATION
DEC2010 MAR2013DEC2012DEC2011
CONCEPTUAL MODEL
MATHEMATICAL MODEL
JUL2010 JUL2011
PROTOTYPE
RISK PLUG-IN/CORE
AGENDA
RISK MODELING IN MULTI-ASSET CLASS AND MULTIMARKET CLEARINGHOUSES
THE CORE MODEL FOR CLEARINGHOUSE RISK CALCULATION
CORE MODEL IMPLEMENTATION
KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
HEDGING STRATEGIES THAT BENEFIT FROM THE CORE MODEL
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KEY BENEFITS DERIVED FROM THE CORE MODEL IMPLEMENTATION
ROBUST MODELLING PROVIDING EFFICIENCY GAINS WITHOUT GIVING UP SAFETY
GREATER EFFICIENCY IN CAPITAL ALLOCATION FOR PORTFOLIOS WITH RISK MITIGATION STRATEGIES (HEDGE)
DEVELOPED SPECIFICALLY TO DEAL WITH THE RISK MANAGEMENT PROBLEM FACED BY CLEARINGHOUSES
TRANSPARENT & INTUITIVE MODEL – ASSUMPTIONS CA BE EASILY VALIDATED
INCENTIVES TO THE ADOPTION OF PRUDENTIAL MEASURES TO MITIGATE RISKS
CIRCUMVENTS THE SILO APPROACH, SO LIQUIDITY FRAGMENTATION IS AVOIDED AND SYSTEMIC RISK MITIGATED
MARKET & LIQUIDITY RISKS ARE TREATED IN BOTH A JOINT AND A CONSISTENT MANNER
