PRMIA Intelligent Risk - December, 2015 by PRMIA Org

INTELLIGENT RISK knowledge for the PRMIA community

PROFESSIONAL RISK MANAGERS` INTERNATIONAL ASSOCIATION EDITORIAL BOARD

INSIDE THIS ISSUE

EXECUTIVE EDITOR Justin McCarthy editor@prmia.org PRODUCTION EDITOR Andy Condurache andy.condurache@prmia.org

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Intelligent Risk - December, 2015

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Letter from Justin McCarthy, Chair PRMIA Board

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Letter from the Executive Director

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CTAs and Commodity Indices by Hilary Till

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Talent development is like farming by Don Levonius

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PRMIA featured sponsor - Numerix by Cheryl Buck

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Escape from The Prisonerâ&#x20AC;&#x2122;s Dilemma By Marc Groz

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Are you ready for Solvency II? Sol Steinberg

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PRMIA Risk Standards of Practice (RSoP) by Julian Fisher

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New PRM accredited program profile The University of Hong Kong by Clement Wong

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New learning opportunities

letter from the chair

Justin M. McCarthy Dear PRMIA Members, It is with great pleasure that I use this last iRisk letter of the year to welcome our new Executive Director – Kraig Conrad – to PRMIA. As per Kraig’s letter in this edition of iRisk, we are looking forward to his vibrant leadership and his work to come with our energized board, staff and volunteers. On this same topic, we at PRMIA were sad to see Kevin Cuff leave us to join the Massachusetts Division of Banks. I would like to take this opportunity to once again thank Kevin for all his work at PRMIA. I am enjoying working with him now in his new capacity as a senior PRMIA volunteer! In my final letter of 2014, I said that PRMIA was poised for a great 2015 – I think that we delivered on this: • We have updated our Professional Risk Manager (PRM™) designation; • We have launched the Operational Risk Manager Certificate (ORM); • We have designed and are about to launch certificate programs in market and credit risk, as well as renewing other educational offerings such as the Associate PRM Certificate;

• We continue to have excellent volunteer-led events in chapters all over the world, once again showing that our volunteers are our greatest asset;

• We continue to work to be a voice for our industry through initiatives such as C-Suite events; Kraig and I attended our first Hong Kong C-Suite event in early November, and we are both committed to continuing and growing our London and New York C-Suite offering that our C-Suite members became accustomed to.

As we move towards 2016, we will need to continue and expand on such initiatives. Kraig will be helping us through his expertise on planning and his stated mission of listening to our members around the world. This process will aid us in expressing a bridging message from PRMIA’s recent successes and on into our future. Please raise your hand to add your voice and energy to our efforts as we further enhance this great organization. Part of the future is in this most recent edition of iRisk, where we have articles on: • • • • •

CTAs and Commodity Indexes by Hilary Till; Talent Development is Like Farming by Don Levonious; Featured Sponsor Interview – Numerix – an Interview by Kristin Lucas; Escape from the Prisoner’s Dilemma by Marc Groz; and, Are you ready for Solvency II? by Sol Steinberg.

I am sure you will enjoy these articles as much as we have enjoyed selecting them. As always, thank you for your continued support for PRMIA - please don’t hesitate to contact me at chair@PRMIA.org. Your thoughts and guidance on this are part of our member-led approach. Justin McCarthy Chair, PRMIA Intelligent Risk - December, 2015

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letter from the executive director

Kraig Conrad It is with great honor that I step in as executive director to help grow this dynamic organization in service of the global risk management profession. With a strong Board of Directors, impassioned volunteers, and dedicated staff, PRMIA is ready to begin a wonderful journey to lead our profession to new heights. To embark on this adventure, we will need new approaches, clear direction, and most importantly, you. As a PRMIA ambassador, your continued support is the key to our success, and it is the cornerstone of the pursuit to elevate our influence in Board rooms, the C-Suite, within the business, and with regulators. The greatest reward for any professional association leader is seeing their community achieve its potential while defining a path forward that once may have been unimaginable. Though PRMIA already has many of the requisite assets to accomplish its admirable and important mission, there is always room to improve.

our strengths The analysis in the first 20 days of my 100-day plan has led me to the conclusion that PRMIA has many assets that, once aligned, will provide tremendous returns. • We have a global network of more than 50,000 risk professionals who engage in our diverse offerings, and our message is heard by nearly 90,000. • Our Board is steadfastly enhancing its governance structure in order to engender an even more resilient culture of leadership that consistently delivers on our objectives. • Our Chapters have a sterling brand that represents us well and delivers our message in local markets. • We have a dedicated staff with over 130 years of professional association management experience. • Our Professional Risk Manager (PRM™) designation, certificates, educational offerings, and events reflect our drive toward leading thought with intellectual rigor while upholding PRMIA Standards of Best Practice, Conduct and Ethics. • The 2015-2016 Action Plan enacted by the Board has begun the process to build resources, connect all in our community, and prepare the organization for growth.

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The Board and staff in early 2016 will develop a strategic plan to align efforts and unlock value for our entire network. A tactical plan then will be created through collaboration with volunteers to sharpen vision and bolster a global brand.

enhancing our capabilities The strategic planning process will focus on a few key areas to support the work of volunteers and staff as we build a powerful organization. Through improved process and timely intelligence, your efforts will be more rewarding and our goals will remain tightly in sight. • Y our association leadership is committed to establishing processes that deliver sharp, relevant messages to drive mission-aligned action and advance leading practice. • W e will instill program development best practices and segmentation analysis to ensure our offering is most powerful in service of our purpose and most pertinent to you at all points in your professional path. • P er the adage that people support what they help create, we will increase collaboration among PRMIA committees and chapters, and with other professional organizations, industry partners, and regulators. • We will revisit the PRMIA Institute as a possible platform for deep thought and research to advance practical practice. • O ur offering will be more global in reach and perspective through expanded programming, greater visibility of PRMIA leadership, and regional-relevancy. The strategic planning process will focus on a few key areas to support the work of volunteers and staff as we build a powerful organization. Through improved process and timely intelligence, your efforts will be more rewarding and our goals will remain tightly in sight.

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PRMIA highlights Risk Management Challenge The PRMIA Risk Management Challenge provides students the opportunity to solve realistic business problems with a risk management focus. Visit www.prmia.org/prmia-risk-managementchallenge to learn more and register a team by December 24, 2015. I would like to thank the CME Group for their support of PRMIA efforts to recognize future risk management leaders.

Robust Risk Organizations PRMIA offers a systematic approach to educating and certifying solid practices in risk teams. Contact Keith Waitt (keith.waitt@prmia.org) to learn more about the value PRMIA can bring to your program.

Share the Value of Sustainer Membership Let your peers know the value of PRMIA chapter events, iRisk Magazine, exclusive best practice white papers, risk videos and podcasts, speaker presentations, and 52 weeks of The Wall Street Journal. Tell them to visit www.prmia.org/individual-membership to learn more about Sustainer Membership and join.

Education and Networking Events PRMIA offers over 200 events each year worldwide, including in-person education and training, webinars, and local chapter meetings. Visit www.prmia.org/events to find events that fit your schedule. I am delighted to be on this journey with a vibrant leadership and energized volunteers. If you are not currently volunteering, please raise your hand. If you have thoughts on how we all can improve, please add your voice to the dialog. You can reach me in our Washington, DC office at kraig.conrad@prmia.org or +1 202.615.3254.

Kraig Conrad Executive Director, PRMIA

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Intelligent Risk - December, 2015

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CTAs and Commodity Indices

by Hilary Till STRUCTURAL SOURCES OF RETURN In the academic literature, one can find strong evidence – historically at least – for there being persistent returns in futures programs due to momentum, roll yield, and also due to rebalancing. This is seen across asset classes, and not just for commodity futures contracts. Each of these return sources will be covered in succession.

momentum Although there are two basic types of CTAs, discretionary and trend-following, the investment category is dominated by trend-followers. “More than 70% of managed futures funds (are estimated to) rely on trend-following strategies,” noted Campbell & Company (2013). In a 2012 AQR Capital Management white paper, the firm showed how persistent momentum profits have been across time and across asset classes. This is illustrated in Figure 1. Hypothetical Performance of Time Series Momentum Strategy performance after simulated transaction costs both gross and net of hypothetical 2-and-20 fees Sharpe Ratio, Net of fees

Correlation to S&P 500 Returns

Correlation to US 10-year Bond returns

9.9%

1.00

-0.05

13.4%

10.1%

0.84

-0.30

-0.59

11.9%

10.4%

0.70

-0.12

-0.11

11.9%

9.7%

0.92

-0.07

0.10

Gross of Fee Returns

Net of 2/20 Fee Returns (Annualized)

(Annualized)

20.0%

14.3%

Jan 1903 - Dec 1912

18.8%

Jan 1913 - Dec 1922

17.1%

Jan 1923 - Dec 1932

17.1%

Time period

(Annualized)

Realized Volatility

Full sample Jan 1903 - June 2012 By decade

Jan 1933 - Dec 1942

9.7%

6.0%

9.2%

0.66

0.00

0.55

Jan 1943 - Dec 1952

19.4%

13.7%

11.7%

1.08

0.21

0.22

Jan 1953 - Dec 1962

24.8%

18.4%

10.0%

1.51

0.21

-0.18

Jan 1963 - Dec 1972

26.9%

19.6%

9.2%

1.42

-0.14

-0.35

Jan 1973 - Dec 1982

40.3%

30.3%

9.2%

1.89

-0.19

-0.40

Jan 1983 - Dec 1992

17.8%

12.5%

9.4%

0.53

0.15

0.13

Jan 1993 - Dec 2002

19.3%

13.6%

8.4%

1.04

-0.21

0.32

Jan 2003 - June 2012

11.4%

7.5%

9.7%

0.61

-0.22

0.20

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AQR constructed a simple momentum strategy as follows. They created “an equal-weighted combination of 1-month, 3-month, and 12-month momentum strategies for 59 markets across 4 major classes – 24 commodities, 11 equity indices, 15 bond markets, and 9 currency pairs – from January 1903 to June 2012,” explained Hurst et. al. (2012). Excerpting further from the AQR authors’ white paper: “Since not all markets have return data going back to 1903, …(they constructed) the strategies using the largest number of assets for which return data existed at each point in time.” They used “futures returns when … available.” And then “prior to the availability of futures data,” they used “cash index returns financed at local short rates for each country” as proxies for futures returns. Each position was sized to “target the same amount of volatility” and “positions across the three strategies … [were] aggregated each month, and scaled such that the combined portfolio … [had a] volatility target of 10%.” Figure 1 shows that “trends appear to be a pervasive characteristic of speculative financial markets over the long term.” The AQR authors theorized that “price trends exist in part due to long-standing behavioral biases exhibited by investors, such as anchoring and herding, as well as the trading activity of non-profit seeking participants, such as central banks and corporate hedging programs.” Assuming these factors continue, the long-term profitability from momentum strategies might also continue, and not just be a matter of history. For further long-term evidence that momentum might be a structural characteristic of markets, one can consider a recent Federal Reserve Bank of Chicago working paper on equities that examined the profitability of momentum strategies in late Victorian-era England and during most of the past eight-and-half decades in the United States. Chabot et al. (2014)’s particular momentum strategies “earned abnormally high riskadjusted returns … between 1927 and 2012 [amongst U.S. equities] and [also] … between 1867 and 1907 ... [amongst English equities].” “However, the … strategy also exposed investors to large losses … during both [historical] periods,” noted the Federal Reserve Bank of Chicago paper. Interestingly, “momentum … [losses] were [apparently] predictable”. In both historical periods, losses were “more likely when momentum recently performed well.” For the 1867 to 1907 period, losses were more likely when “interest rates were relatively low.” And for the 1927 to 2012 period, losses were more likely when “momentum had recently outperformed the stock market”. Each of these periods were “times when borrowing or attracting return chasing ‘blind capital’ would have been easier.” The authors argue that the large periodic losses, associated with the strategy plausibly becoming too popular, “play an important role in sustaining” the momentum strategy’s historical returns. The Federal Reserve Bank of Chicago paper raises the question that a sizeable fraction of investors might not capture the documented, historical (but hypothetical) returns of momentum strategies since they may only enter the strategy after it has done well and then exit it once it has performed poorly. This explains why a strategy can potentially continue to exist, even if well known: investors may not be able to tolerate the periodic interim drawdowns, especially if they do not have a firm grasp on why a black-box strategy should be profitable.

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roll yield In addition to momentum, the empirical literature also documents that “roll yield” can be considered a structural source of return, at least over long periods of time. A 2014 Campbell & Company white paper attempted to demystify roll yield. Futures returns “and spot returns on the same underlying asset often diverge, and the magnitude of this divergence is known as the futures ‘roll yield,’” according to Campbell & Company (2014). Excerpting further from the Campbell & Company white paper: “The cumulative impact of roll yield can be quite significant, in some cases being similar in magnitude to the entire gain or loss an investor experiences over the lifetime of a trade.” In summary, “the roll yield represents the net benefit or cost of owning the underlying asset beyond moves in the spot price itself.” “The spot return and roll yield together comprise the total return experienced by an investor (net of financing costs.)” Figure 2 shows the “benefits and costs relevant to selected asset classes.” For each asset class, the roll yield can be arrived at by deducting the cost of holding the asset from its benefit.

figure 2 Benefits and cost of holding selected Asset Classes Asset Class

Benefits

Costs

Bonds

Current Yield (Bond Coupon) 1

Financing Rate

Currencies

Foreign Deposit Rate

Local Deposit Rate

Stocks

Dividend Yield

Financing Rate

Volatility

Hedging Against Increases in Volatility*

Insurance Premium*

Commodities

Convenience Yield*

Storage; Transport; Insurance; Financing Rate

*Non cashflow terms: “In fixed income markets, there is an additional component to returns called the yield curve ‘rolldown’ (unrelated to futures roll yield) which occurs over time as the bond cash flows experience different points along the yield curve.” Source: Campbell & Company, 2014, “Deconstructing Futures Returns: The Role of Roll Yield, Campbell White Paper Series, February.

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This net benefit or net cost shows up in an asset class’ futures curve. If there is a net benefit to holding the commodity, then a futures contract will be priced at a discount to the asset class’ spot price, reflecting this benefit. Correspondingly, if there is a net cost to holding the commodity, then a futures contract will be priced at a premium to the asset class’ spot price, reflecting this cost. One can also think of these discounts and premiums as positive carry and negative carry, respectively. While returns due to highly volatile spot-price changes may dominate performance-attribution calculations in the short-term, returns due to roll yield (or carry) increase in importance over long timeframes. For example, Campbell & Company (2013) described a proprietary trend-following benchmark, in which they calculated returns from 1972 through November 2012, and which included a selection of equity, fixed income, foreign exchange, and commodity markets. Over this 40-year period, approximately half of the benchmark’s cumulative performance was due to spot return, and the other half was due to roll yield. This particular calculation excluded the impact of interest income. So clearly investors should pay attention to roll yield. Returning to the table in Figure 2, which shows the benefits and costs of holding selected asset classes, “for financial assets, these represent actual cash flows, while other assets may have non-cash flow costs and benefits [such as] the convenience yield in the case of commodities.” The “convenience yield [in turn] reflects the benefits to holding a physical commodity, which tends to be more valuable when inventories are low or shortages are expected.” For commodity traders, grasping the importance of the convenience yield is quite important. We can refer to roll yield as the net convenience yield; i.e., the benefit of holding the commodity netted against its costs. Paying attention to the net convenience yield, or roll yield, is useful over short horizons and separately, over long horizons. Over short horizons, given that the roll yield increases during times of shortage, this factor provides a useful price proxy for fundamental data that can be used as a timing indicator for positions in a particular commodity market. That is, one would only go long a particular commodity futures contract if one has an indication of scarcity. An example of using roll yield as a short-horizon timing indicator is provided in a later section of this paper. Over long horizons, the roll yield is important for commodity futures contracts. This is because of another structural feature of commodity markets: mean reversion. As noted in Geman (2005), “commodity prices neither grow nor decline on average; they tend to mean-revert to a level which may be viewed as the marginal cost of production. This has been evidenced a number of times in the literature … [for both] agricultural … and … energy commodities. Hence, mean-reversion is one of the main properties that has been systematically incorporated in the literature on commodity price modeling.” If a commodity has a tendency over long enough time frames to mean-revert, then by construction, returns cannot be due to long-term appreciation (or depreciation) in spot prices. In that case, over a sufficient timeframe, the futures-only return for a futures contract would have to collapse to its roll yield. Can we observe this historically in commodity futures markets? The answer is essentially yes (although with one exception, which will be covered in the next section of the paper).

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Feldman and Till (2006) examined three agricultural futures markets from which one could obtain price data since 1949. The authors had originally wanted to obtain continuous price data that was longer than this, but this was not possible because during WWII there had been price controls that stopped trading on the Chicago Board of Trade. So the dataset had to begin at the point that futures markets had fully recovered, post WWII. In the 2006 paper, the authors found that over a 50-year-plus timeframe, the returns of three agricultural futures contracts were linearly related to roll yield across time, but this result only became apparent at five-year intervals. Five-Year annualized excess return vs. Average backwardation (1950 to 2004)

figure 3 40 % Annualized 5-year return

30 % wheat trend

20 %

corn trend

soy trend

10 % Soybeans

Corn -10 %

Wheat

-20 % -30 % -4 %

-3 %

-2 %

-1 %

Average backwardation Graph based on research undertaken during the work that led to the article by Feldman and Till (2006).

At this point in the paper, it is necessary to define some commodity futures contract terminology. When a deferred futures contract trades at a discount to the spot price, we call this futures curve shape: backwardation. And when the deferred futures contract trades at a premium to the spot price, we call this futures curve shape: contango. A futures contract that is structurally backwardated will on average have positive roll yield; while a futures contract that is structurally in contango will on average have negative roll yield. Figure 3 shows the futures-only returns of corn, soybeans, and wheat over 5-year timeframes against each contractâ&#x20AC;&#x2122;s average curve shape. The average curve shape in turn is linearly related to the average roll yield for the contract. Instructively, the data points that do not fit the expected linear relationship were from the early 1970s during the devaluation of the dollar. So at least from the evidence of Figure 3, we would say there have been two drivers of long-term futures-only returns in the agricultural markets: (1) the roll yield; and (2) the revaluation of real assets during a substantial currency devaluation. Figure 3 focused on understanding the returns of particular commodity futures contracts across time. In contrast, Figures 4 and 5 focus on examining the return drivers, across commodities, over 15-to-21-year timeframes. Figure 4 shows annualized returns of commodity futures contracts versus the curve shape from 1983 to 2004 whereas Figure 5 provides an updated view from January 1999 through June 2014. 012

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figure 4

25 %

Annualized excess return vs. Average backwardation (1983 to 2004)

20 %

Brent

(since 8/86)

Gas Oil

(since 6/86)

Gasoline Crude Oil

15 %

Copper Heating Oil Live Cattle

10 %

Platinum

Annualized return

Lean Hogs

Soy Meal

Soy Beans

Cotton

Gold Bean Oil Sugar

-20 %

-15 %

-10 %

Natural Gas

-5 % Caffee Silver

Cocoa

(since 4/90)

10 %

15 %

Wheat

-5 %

Corn

-10 %

Annualized return

25 %

figure 5

Gasoline

20 %

Roll Returns and Excess Returns 1/1999 - 6/2014

Brent Crude

Gasoil Heating Oil Crude Oil

15 %

Copper

Lead

Silver

10 % Gold Sugar

Average excess return

Nickel

Cocoa Zinc

Soybeans

Feeder Cattle

0% Kansas Wheat

Lean Hogs Corn

Live Cattle Aluminium

-5 % Cotton

Coffee Wheat

-10 %

Natural Gas

-30 %

-25 %

-20 %

-15 %

-10 %

-5 %

Average Roll Return Graph based om Armptt (2014), Slide 16.

Market & Zimmermann (2008), p. 138: â&#x20AC;&#x153;The roll return captures the slope of the term structure of the future prices and can be positive (...backwardation) or negative (...contango).â&#x20AC;? Intelligent Risk - December, 2015

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One might conclude that at least over very long timeframes, the roll yield has been a meaningful driver of returns in commodity futures contracts. How has a strategy linked to roll yield performed recently? Figure 6 is excerpted from a recent Barclays presentation on the performance of their Backwardation Alpha Index. This index takes a long position in the ten most backwardated commodities and shorts the Bloomberg Commodity Index.

figure 6 Performance of selected Commodity Index Strategies

Annualised (%) Trend (except for YTD)

5-year strategy YTD

Backwardation

-10 %

-5 %

10 %

Source of graph: Excerpted from Norrish (2015), Slide 17.

Through July 2015, this index had annualized year-to-date returns of 1.9%, and 5-year annualized returns of 5.4%. This paper had noted earlier that one could use roll yield as a proxy for fundamental data, and that one might only consider entering into a long position in a particular futures contract if one had an indication of scarcity. Historically there has been a substantial return difference, depending on whether one holds WTI oil futures contracts unconditionally versus only if the first-month futures price minus the second-month futures price is positive: i.e., if the front-to-back spread is in backwardation (and, therefore, has a positive roll yield.) The annualized returns from 1987 through the end-of-August 2014 for holding and rolling WTI futures contracts were 6.2% per year over T-bills. Correspondingly, the returns over the same period for only holding a WTI futures contract when the contractâ&#x20AC;&#x2122;s front-to-back spread was in backwardation were 12.8% per year over T-bills.

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Examining a more recent timeframe, starting in July 2014 the Brent futures market went into contango pretty much continuously. If a trader or investor had elected to only buy and roll Brent futures contracts when the contract was backwardated, then that trader’s returns would have been quite different from the returns of a passive investor in Brent contracts, as illustrated in Figure 7. figure 7 Futures Value of $1 Unconditionally Investing in Brent Oil Futures vs. Only Investing if Brent is Backwardated (12/31/13 to 12/15/14) 1.1 1 0.9 0.8 0.7 0.6

20 4.

20 1.

20 7.

20 6.

20 2.

20 9.

20 7.

20 3.

20 2.

20 8.

20 5.

20 1.

20 8.

20 4.

.3 12

0.5

Brent Futures Excess Returns Brent Futures Excess Returns only if front-to-back spread >= 0 Source of Data: The Bloomberg. The Bloombert ticker used for calculating Brent Futures-Only Returns is “SPGSBRP <index>”.

Perhaps a structural holding in crude oil can only be justified if the contract is in backwardation. Obviously, though, one must be very careful with any back-tested results in making future predictions about the utility of any one factor.

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“rebalancing return” So far this paper has only discussed return drivers at the individual futures contract level. The meanreversion of commodity prices can also have meaningful consequences for returns at the portfolio- or index-level. Specifically, this feature is at the root of an additional source of return, quite separate from trends in spot prices or the potential persistence of curve-structure effects. That additional potential source of return is the return from rebalancing. Erb and Harvey (2006) discussed how there can be meaningful returns from rebalancing a portfolio of lowly-correlated, high-variance instruments. “Commodity futures contracts happen to display … [these] characteristics …,” noted Sanders and Irwin (2011). Figure 8 demonstrates that two assets that have complete round turns in their price levels can, when combined and rebalanced each period, actually have a positive portfolio-level return. figure 8 Price Asset 1

Price Asset 2

Return Asset 1

Return Asset 2

Equal Weighted Return

100%

200%

150%

50%

33%

42%

33%

25%

29%

25%

20%

23%

-33%

-17%

-20%

-75%

-48%

-25%

100%

38%

-33%

-17%

-50%

Arithmetic Average

24%

17%

Geometric Average

Time

Table based on Sanders and Irwin (2012), Table 2

The rebalancing effect was explained in Greer et al. (2014), as follows: “A ‘rebalancing return’ … can naturally accrue from periodically resetting a portfolio of assets back to its strategic weights, causing the investor to sell assets that have gone up in value and buy assets that have declined.” Erb and Harvey (2006) concluded, in turn, that the returns from rebalancing are the one “reasonably reliable source of return” from owning (and rolling) a basket of commodity futures contracts. The issue, yet again, like roll yield, is that the rebalancing effect will not be apparent over short horizons.

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CONCLUSION Based on a brief review of academic and practitioner articles, this paper noted that there may be structural returns in futures strategies as a result of momentum, roll yield, and rebalancing. One caveat is that one’s holding period may have to be quite long term for these return effects to be apparent. That said, even structurally positive returns may be insufficient to motivate investors to consider futures products. A CTA investor may require that the program’s return profile is also long-options-like, as covered in Till (2006); and an institutional investor will expect that a commodity index will provide diversification for a stock-and-bond portfolio as discussed in Till (2014).

ENDNOTES Research assistance from Katherine Farren, CAIA, of Premia Risk Consultancy, Inc. is gratefully acknowledged.

BIO Hilary Till is a co-founder of Premia Research LLC, a consulting firm that designs indices. She is also the coeditor of “Intelligent Commodity Investing,” a bestseller for Risk Books. Ms. Till presently serves on the North American Advisory Board of the London School of Economics; is a member of the newly formed Research Council within the J.P. Morgan Center for Commodities at the University of Colorado Denver Business School as its Solich Scholar; and is a Research Associate at the EDHEC-Risk Institute, in Nice, France. In Chicago, Ms. Till is a member of the Federal Reserve Bank of Chicago’s Working Group on Financial Markets; is an Advisory Board Member of DePaul University’s Arditti Center for Risk Management; and is a steering committee member of the Chicago chapter of PRMIA. She has a B.A. with General Honors in Statistics from the University of Chicago and an M.Sc. degree in Statistics from the London School of Economics (LSE).

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references 1. Arnott, R., 2014, Research Affiliates, Commodity Presentation, S&P Dow Jones Indices’ 8th Annual Commodities Seminar, London, September 11. 2. Campbell & Company, 2013, “Prospects for CTAs in a Rising Interesting Rate Environment,” Campbell & Co. White Paper Series, January. 3. Campbell & Company, 2014, “Deconstructing Futures Returns: The Role of Roll Yield,” Campbell & Co. White Paper Series, February. 4. Chabot, B., Ghysels, E. and R. Jagannathan, 2014, “Momentum Trading, Return Chasing, and Predictable Crashes,” Federal Reserve Bank of Chicago Working Paper, November. 5. Erb, C. and C. Harvey. 2006, “The Tactical and Strategic Value of Commodity Futures,” Financial Analysts Journal, Vol. 62, No. 2, March/April, pp. 69-97. 6. Feldman, B. and H. Till, 2006, “Backwardation and Commodity Futures Performance: Evidence from Evolving Agricultural Futures Markets,” Journal of Alternative Investments, Vol. 9, No. 3, Winter, pp. 24-39. 7. Geman, H., 2005, Commodities and Commodity Derivatives (Chichester: John Wiley & Sons). 8. Greer, R., R. Walny and K. Thuerbach, 2014, “We See Opportunities in Commodities,” PIMCO Viewpoint, March. 9. Hurst, B., Ooi, Y. H. and L. Pedersen, 2012, “A Century of Evidence of Trend-Following Investing,” AQR Capital Management, Fall. 10. Markert, V. and H. Zimmermann, 2008, “The Relationship Between Risk Premium and Convenience Yield Models,” in F. Fabozzi, R. Füss and D. Kaiser (eds) The Handbook of Commodity Investing (Hoboken: John Wiley), pp. 113-144. 11. Nash, D. and B. Shrayer, 2005, “Investing in Commodities,” Morgan Stanley, Presentation, IQPC Conference on Portfolio Diversification with Commodities, London, May 24. 12. Norrish, K., 2015, “Commodity Investing After the Supercycle,” Barclays Commodities Research, September. 13. Sanders, D. and S. Irwin, 2012, “A Reappraisal of Investing in Commodity Futures Markets,” Applied Economic Perspectives and Policy, Vol. 34, No. 3, September, pp. 515–530. 14. Till, H., 2006, “How to Include Hedge Funds in a Risk Allocation Framework,” EDHEC-Risk Publication, August, Available here. 15. Till, H., 2014, “An Update on Empirical Relationships in the Commodity Futures Markets,” CME Group White Paper, February 28. Available here.

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talent development is like farming

by Don Levonius, MA We live in a high-tech, high-speed age in which virtually everything we want is available in no time at all. Do you have bills due today? Just whip out your phone and pay online. Want in on that hot new investment opportunity? There’s an online trading app for that. Need the latest gizmo everyone is talking about? Shoot over to that store that never closes or surf to that online retail site with the lightning fast distribution channel that works around the clock to ensure you can acquire anything you desire overnight and with free shipping. Let’s be honest. We want what we want when we want it, and we have been conditioned to expect our desire for immediate gratification to be fulfilled. So it is no wonder some people think talent development works that way, too. However, developing employees is not a simple transaction, and the product of talent

development is not a commodity. Unlike a tangible product manufactured in a factory to be acquired by consumers, the product of talent development is employee knowledge, skills, and abilities (KSAs). KSAs are not manufactured but developed through a protracted process called learning, which naturally occurs when learners are exposed to information, ideas, and experiences and motivated to change as a result. Talent development is not transactional; it is transformational. Leaders cannot assemble or ship knowledge, skills, or abilities to passive consumers on demand, nor should we try. Rather, we must cultivate conducive learning environments, plant relevant information and ideas, intentionally expose learners to elements and experiences, and nurture them as they strive to grow. The rest of the transformation is up to them.

cultivating fertile soil Whether you are conducting formal training in a physical classroom or online learning platform or providing informal on-the-job training out in the field, your first step is to cultivate fertile “soil.” Is your formal learning environment a safe, nurturing atmosphere where employees can open their minds, interact with others, consider new ideas, share thoughts and opinions, and experiment with newly learned skills? Are the offices and operations where employees receive informal on-the-job training conducive to learning? Are employees able to experiment with new skills and practice new techniques without fear of being criticized or embarrassed? The environment in which formal and informal training occurs greatly influences whether or not learners experience growth there.

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According to Abraham Maslow, people must have their most basic needs met before they can focus their motivation toward satisfying higher level needs. Maslowâ&#x20AC;&#x2122;s Hierarchy of Needs suggests that, for example, for learners to concentrate on what goes on in a classroom they must not be hungry, thirsty or tired. Making sure learners have ample breaks and mealtimes is, therefore, essential. Even when we are not able to provide food and beverages, we must ensure they have ample downtime and can find the nourishment they need. Otherwise, they will wilt.

promote self-esteem and self-actualization? Adult learners like to be recognized for their knowledge and experience, and they do not like to be treated like children. Consider enabling them to use the tools and resources they rely on day to day, such as social networking, smartphones, company systems, and search engines. Encourage leaders to validate those engaged in on-the-job training and build their confidence as they apply newly learned skills. Include progress meters in your eLearning and congratulate learners when they complete each section or level.

Maslowâ&#x20AC;&#x2122;s Hierarchy also suggests we must provide a learning environment that is safe and free of threats. Does your online learning platform, LCMS, or LMS secure learner information? Does your classroom based training protect learners from physical, psychological, and emotional threats? Do your eLearning voiceover scripts contain inclusive language and avoid expressions that may confuse learners for whom English is a second language? Does your on-the-job training protect employees from harsh criticism and public humiliation?

Just as farmers add fertilizer and nutrients to their soil based on the specific crop they seek to grow, leaders must ensure learning environments contain precisely what our learners need to succeed. What is it you want learners to do, or do better, as a result of your training? Specify precisely which performance issues you want your training to address. Clearly identify the skills you want employees to master as a result of your training and give individualized consideration to the unique experiences, competencies, and needs of each learner participating in it.

According to Maslow, in addition to ensuring the physiological and emotional safety of our learners, we must also cultivate learning environments in which learners feel as though they belong. What do you do to promote a sense of affiliation among new and existing employees? Do you provide name badges or tent cards, or enable classroom learners to introduce themselves? Do your webinars include breakout sessions so learners can work in small groups? Do learners see their names when they log into your learning portal? Do employees engaged in on-the-job training feel like they are helping the operations team rather than in its way? Moving up in the hierarchy, does the environment in which your training occurs contain nutrients that

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planting seeds Once the soil of our learning environment is ready, we can begin planting â&#x20AC;&#x153;seedsâ&#x20AC;? learners will transform into KSAs. These seeds should include thought-provoking and innovative ideas, right- and left-brain activities, and knowledge-sharing that stimulates critical thinking and creativity. Does your training allow enough time for your seeds (ideas, information, and skills) to germinate? Do you periodically pause so learners can reflect, share what they have learned, and ask questions? Do you allow enough time for skill practice? Do you spread training over multiple sessions and allow learners to move on only after they demonstrate mastery? Unlike factory workers who can crank up production and work around the clock to increase output, farmers operate within the laws of nature. Farmers may only plant so many seeds per acre, they have little control over how fast their crop grows, they can only reap what they sow, and they can only harvest a crop after it has reached maturity. Like farmers, we must plan well and exercise patience. There is a point of diminishing returns in talent development, meaning that if we plant too much content in too little training time, neglect to plant that content deep enough, or push it to mature faster than naturally possible, we may actually inhibit growth.

nurturing growth A one-size-fits-all approach may work in manufacturing, but farming is much more conditional. Factory workers repeatedly use the same ingredients and processes to produce identical results. However, farmers must constantly monitor environmental conditions and the impact of those conditions on the health and growth of their crops. The same is true of talent development. Just as farmers pay close attention to the weather and adjust their strategies accordingly, trainers and facilitators must discern whether learners are thirsty for more information or have reached a point of saturation. Are there natural points at which learners can pause your eLearning, save their progress, and step away for a while? Do your facilitators recognize the non-verbal signs that indicate learners want more information, have questions, or need a break? Do your on-the-job trainers take employees off-line periodically, away from the busyness of the operation, to discuss what they have learned? With classroom based training, it is also important to monitor environmental factors like room temperature and periodically make necessary adjustments to ensure learners can remain focused. Moreover, like farmers, facilitators must keep an eye out for pests and other intruders that threaten or undermine learning conditions or jeopardize growth. Do your trainers know how to manage difficult participants and other classroom distractions? 022

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accepting the laws of nature Talent development is like farming, the product of which is not produced but grown. Leaders and talent developers must cultivate favorable learning environments, plant the right types and amounts of information, and continually monitor environmental conditions to nurture learners as they grow in knowledge, skills, and abilities. The rest is up to them.

author Don Levonius is a consultant, trainer, and national public speaker specializing in leadership and ethics. He draws on over 17 years of leadership, including 13 years with Disney where he managed loss prevention and fraud investigations, led post-9/11 security training, and subsequently held senior leadership positions in learning and development. Don is currently principal consultant with Victory Performance Consulting LLC and field editor for the Association of Talent Development. He holds graduate degrees in business & organizational security management and human resource development.

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PRMIA featured sponsor - Numerix

by Cheryl Buck Education thought leadership, networking and opportunity converge when PRMIA offers sponsored chapter events for its members, providing benefits for all involved. PRMIA has been pleased to partner with Numerix, a leading provider of pricing and risk analytics software solutions over the past three years to facilitate timely and relevant discussions in a wide array of learning and networking opportunities. Recently, Kristin Lucas, Director of Operations for PRMIA, had a discussion with Steve O’Hanlon, CEO and President of Numerix and James Jockle, CMO to identify the benefits that stakeholders receive through a collaboration with PRMIA. According to Steve O’Hanlon, “It is the perfect marriage for us, that allow us to not only necessarily go out and sell to PRMIA members, but to provide valuable thought leadership – something that we have been doing as a company for many years.” James Jockle indicated that “We pride ourselves on having people in the company who have advanced academic and mathematic backgrounds. In fact, we consider the four original quants that have been with us since 1997 to be the cornerstones of our company. As thought leaders, they help to educate the industry and provide that same level of professional enrichment to our clients and prospects.” PRMIA and Numerix have worked together on a series of successful Global Chapter Events as well as on a range of Master Class Series offerings. In addition, through its collaboration 024

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the two organizations have produced a number of Roundtable Discussions for C-Level PRMIA members. “Numerix has always had wonderful experiences with PRMIA, but the concept of a vendor engaging with the PRMIA audience was something radical and new when we started this back in 2011,” shared Mr. Jockle. When asked to identify something in the relationship that stands out, Mr. Jockle indicated that “What I love about working with PRMIA is that there’s no fear in trying new things.” The London Master Class concept, for example, was a new offering executed in 2015. Numerix and the PRMIA chapter leaders worked together to launch this unique learning opportunity where 30 risk professionals came together for an indepth session focusing on the negative interest rate environment impacting the Eurozone. The class was videotaped, and post-event was distributed via PRMIA and Numerix networks. This new approach proved to be an impactful and innovative way to open up Numerix and PRMIA expertise to not only to the London chapter but to all PRMIA chapters across the globe. The ongoing collaboration between PRMIA and Numerix continues to bring risk thought leadership and discussions directly to PRMIA members enhancing their individual areas of expertise and the value they provide to their professions. Trying new offerings, like the Master Class concept, also helps to keep learning opportunities fresh.

Creating Chapter “Road Show” seminars with Numerix in targeted markets was also a new initiative that involved crafting a seminar series based on a single topic for each location. Mr. O’Hanlon agrees having seen a dual benefit result for both members and sponsors at these events: “Members of the PRMIA community have given us feedback that helps Numerix become better in our messaging and the delivery of our product. We are also able to better identify what is needed by all involved in the risk arena that helps us to be competitive and provide improved tools to a more diverse range of risk professionals.” C-Suite Roundtable Discussion sponsorships benefit members and sponsors by providing a secure location for the high-level risk discussions that transpire amongst those gathered. “It is not just what we want to bring to the table, but also the chance to have that Chatham House Rules discussion with high-profile individuals that has been enlightening for us, and has helped us think differently as we are building new elements and features into our products. We do not only think about the trader at the desk or the middle office risk professional; it is also the individuals at the top that matter as well,” said Mr. Jockle. As a result of these discussions, C-level members of PRMIA looking for risk solutions today or in the future walk away with a point of contact, and often times compelling information on a unique company and set of solutions. Mr. Jockle adds, “The C-Suite Discussion allows the audience to determine if our expertise aligns with their needs, potentially helping them to make a more informed choice about vendor selection in the future. C-Suite discussions provide the opportunity for C-level peers and the sponsor to engage in one-on-one conversations with the decision makers that matter most.” Kristin Lucas sums it up best when she notes that the best relationships with sponsors are those in which both parties benefit: “The PRMIA member’s event experience is enriched by the sponsor’s thought leadership, and the sponsor’s product development and delivery is enriched by the feedback received from members. PRMIA values the relationship it has had cultivated with Numerix. The give and take between our two organizations has created a true partnership and has resulted in worthwhile learning opportunities for risk professionals worldwide. Sponsor contributions to PRMIA’s membership are recognized and appreciated, and we look forward to creating many more opportunities for the future.” PRMIA sponsors are a key component to supporting PRMIA’s mission to provide an open forum for the development and promotion of the risk profession. Through the PRMIA Sponsor Spotlight, we seek to acknowledge organizations that we have created partnerships with to provide value to our members and enhance the risk profession. To find out how your organization can benefit by reaching out to PRMIA risk professionals worldwide, please contact sponsorship@prmia.org.

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interviewees Steven O’Hanlon Chief Executive Officer and President, Numerix Steven O’Hanlon is a dedicated visionary, who inspires bold change and flawless execution. Since first joining the company in 2002, and under his leadership as President & COO starting in 2004, Mr. O’Hanlon has driven the transformation of Numerix from a broadlyfocused company with many disparate products and five locations, to a global analytics software company operating from a single platform with a presence in 26 countries. In his early years with the company Mr. O’Hanlon aggressively pursued the derivatives pricing business and by 2008 established Numerix as a global leader of financial analytics software. Witnessing firsthand the impact of the financial crisis, under Mr. O’Hanlon’s leadership, Numerix made a key decision to re-evaluate its core analytics solution and creatively determine how it could be maximized to pivot the organization into the rapidly changing market of derivatives risk management. Through his ability to focus, adapt and execute – Mr. O’Hanlon was named CEO of Numerix in January 2013. Through Numerix’s continued investment in innovative technologies, unrivaled analytic capabilities, and a customer-centric solution selling approach, the company has been firmly planted as the most prolific and dominant leader in both risk and pricing. To date, the company has been recognized with over 100 international awards including being named one of the fastest growing companies in North America by Inc. Magazine’s 500|5000 and Deloitte’s Technology Fast 500™. Mr. O’Hanlon’s personal achievements include being named one of New York SmartCEO’s Future 50 rising stars, as well as being ranked annually on Institutional Investor’s “Tech 50” and “Trading Technology 40” Lists.

James Jockle Chief Marketing Officer & Senior Vice President, Global Marketing & Corporate Communications, Numerix As Chief Marketing Officer and Senior Vice President of Global Marketing & Corporate Communications, Mr. Jockle leads the company’s global marketing and corporate communications efforts, spanning a diverse set of solutions and audiences. He oversees integrated marketing communications to clients in the largest global financial markets and to the Numerix partner network through the company’s branding, electronic marketing, research, events, public relations, advertising and relationship marketing. Since joining Numerix in 2008, Mr. Jockle has launched the organization’s award-winning thought leadership program, bringing to light challenges and insights from Numerix market experts. Mr. Jockle also hosts the Numerix Video Blog to tackle the challenges pressing the derivatives markets—from regulatory issues to trading strategies. 026

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escape from The Prisoner’s Dilemma

by Marc Groz A small change in the structure of a classic construct in game theory holds the promise of big changes in economic and other human behaviors. The Prisoner’s Dilemma is a well-known construct in game theory, illustrating how completely “rational” individuals may fail to cooperate, against their apparent best interests. The original example, formulated in 1950, has two prisoners held in separate cells and unable to communicate with each other. The authorities offer each of them a chance to go free by implicating the other. The catch is that if each implicates the other, they get a heavier penalty than if neither implicated the other. Thus, the dilemma, to cooperate (and risk being a “sucker”) or to compete (and lose the chance for a lighter sentence). In classic economic thought, the “rational” answer is to betray the other because (in a single play of the game) this strategy always creates more “utility” than cooperation. Much mathematical, psychological, and economic literature has explored and elaborated on this simple paradigm. What happens, for example, if the game is played more than once? The best strategy would then be the one that on average creates the most utility for a player. It turns out that cooperation some of the time is the best strategy, with the caveat that players must be ready to betray on a “tit for tat” basis to keep the other player from exploiting the first player’s cooperative behavior. My interest in the prisoner’s dilemma was heightened when I began a program of invention

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some years ago. I immersed myself in thinking about the complexities of getting something really new from “the lab” to the market. I knew that I would need a lot of help and that this involved getting people with widely disparate interests and capabilities to cooperate. It occurred to me that frequently, people hold back from behaving in a generous, cooperative fashion not out of mean-spiritedness, but rather because of a deep fear and unwillingness to be taken advantage of, just as may happen in the prisoner’s dilemma. What if, I wondered, this fear could be eliminated? What if it was somehow possible to eliminate the risk of another player (or players) free-riding on the generosity of one or more “right-minded” players? In short order, I imagined a new game, which may be called “the prisoner’s trilemma”. In it, each prisoner is given not two, but three choices: to cooperate, to betray, or to cooperate if and only if the other player cooperates. This third choice is what I call a “contingent commitment” and it may be made in confidence to a special computer system called a “contingent commitment facility”. Equiped with this third choice, the players are no longer doomed to act as “rational betrayers” who end up with less utility than if they had they cooperated together. By making a contingent commitment to cooperate, they avoid the risk of being betrayed by the other player, while retaining the benefit of cooperation.

This small change in the structure of a game may have large, beneficial consequences for people all over the world. For example, job creation and economic development may be facilitated by contingent commitments of key stakeholders. This possibility was mentioned by Joe Nocera in a New York Times Op Ed: …companies quickly lay off workers, many of whom never find their way back into the full-time labor force. Corporations shy away from investing for the future, even though investment is what will turn the economy around. The government, for its part, invariably starts talking about “job creation,” but rarely does anything that makes a difference…. There is, of course, another reason corporate executives might be reluctant to sacrifice short-term profits by putting people to work. What if their competitors didn’t go along? Then they would find themselves at a disadvantage. Useem would tackle that by having a credible group like the Business Roundtable leading the charge, rounding up companies that would agree to start hiring. But Marc Groz, a financial risk expert I’ve gotten to know, has what I think is a more intriguing approach, which he calls a “contingent commitment facility.” “Everyone is waiting for someone else to go first,” he told me the other day. Using his facility, a company would agree to hire X number of new workers. But the commitment would only become binding if certain conditions were met — such as having other companies in the same industry agree to do likewise. Once that happened, all the companies would have to do what they’d promised. New York Times article available here. Here is an example excerpted from my patent.

job creation example In another exemplary embodiment, consider a neighborhood within an American city of approximately 100,000 people. The neighborhood contains approximately 10% of the homes and businesses of the city. Of the approximately 10,000 residents, 3,000 have jobs and half of those jobs are in the local neighborhood. Another 1,500 people from outside the neighborhood commute in, bringing the total number of jobs in the neighborhood to 3,000. At one intersection, there is a coffee shop, a small supermarket, a furniture store, and a small factory. All told, these four businesses employ 150 people, 5% of the total number of people employed in the neighborhood. 75, or half of that total, are also residents; the other half reside elsewhere.

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These four businesses are a small part of an economic web that extends throughout the neighborhood, and an even smaller part of the larger webs that extend throughout the city, state, region, nation, and globe. As such, they are a microcosm of how one or more suitably configured CCFs may bring about many new jobs, through benign cooperation between members of these economic webs that lets them overcome their fear and get growth going again. 50 of the 150 workers at this particular crossroads work at the supermarket, another 75 work at the factory, 15 at the furniture store, and the remaining 10 at the coffee shop. A CCF for this â&#x20AC;&#x153;model ecosystemâ&#x20AC;? may be implemented as follows: the CCF server receives data from each of the four businesses about its respective current sales and number of employees; it transmits an initial list of contingent commitments for each business to consider, request that each business add the greater of (1 extra worker, 5% of existing workforce). This translates into 1 extra worker at the coffee shop, another extra worker at the furniture store, 2.5 extra workers at the supermarket, and letâ&#x20AC;&#x2122;s say 4 (rounding up) extra workers at the factory. These additional hires would be conditional on all four of the participants making their respective commitments, and the existing and newly hired workers making the following additional commitments: workers at the 3 non-coffee shop businesses and/ or other members of the community contingently agree to patronize the coffee shop in sufficient number to at least justify the cost of hiring the additional employee. Assuming that the additional employee costs the coffee shop $500 per week, this would be satisfied if 100 individuals committed to spending $10 per week and half of that $1,000 in incremental revenue being available to pay for the additional worker. Similarly, workers and others contingently agree to spend more at the furniture store and the supermarket, and local businesses agree to spend more at the factory. When a sufficient number of contingent commitments have been received, critical mass is achieved and the commitments may become binding. Alternatively, the commitments may remain non-binding until other neighborhoods reach their critical mass. In a preferred alternative embodiment, the commitments are made contingent on the operation of one or more additional CCFs, whose commitments are in turn made contingent on the first CCF. In other words, a multiple-level CCF, is established in which the satisfaction of contingent commitments at the local level is a step towards the creation of binding commitments at a higher level, such as the city, state, region, or nation as a whole. The conditions under which contingent commitments become binding commitments may be determined in advance as a precondition for entry into the CCF, or said conditions may be decided by one or more operations of the CCF. For example, the local CCF may be set up with the condition that at least 3 other localities must have reached first-level Binding commitments and have a second-level agreement that all 4 localities will convert their first-level binding commitments into actual binding commitments once all four have first-level binding commitments. In a multi-level CCF, only the top level binding commitments are actually binding. Binding commitments may be divided to arrive at within a multi-level CCF into contingently binding commitments and absolutely binding commitments. 030

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A small team of financial technologists may deploy a functioning single-level CCF in a matter of weeks. More complex implementations of multiple CCFs, linked together in series, in parallel, hierarchically, or in a combination of the aforesaid and/or other topological configurations, may take substantially longer to deploy. A CCF may operate at the level of a local community, gathering and processing the Contingent commitments of members of that community. It may also operate at higher levels of the political/ economic system, such as city (or county), state, regional, national, or international levels. One or more CCFs may operate on one or more levels simultaneously and/or sequentially. Clear, measurable results would be visible in the real-time data received by said one or more CCFs. Use of a computer system and/or other information technology for transmitting, receiving, storing and/or processing Contingent commitments may facilitate reaching critical mass quickly, while protecting the privacy and confidentiality of workers, companies, and other parties involved. One might worry that the CCF might work too well, allowing our economy to overheat and igniting a ruinous inflation. But this worry is misplaced, as Contingent commitments can be used to slow an overheated economy as well as to speed up an economy frozen by fear. In fact, had a CCF been available in the run-up to the financial crisis, incentives to take too much risk could have been defeated with actionable incentives to control risk properly. This idea has the potential to go viral, with social media, websites, blogs, apps, and traditional print and broadcast media joining to transform the tide of fear into a tide of hope. Social media may preferably play a special role, as one or more CCFs may be linked to or embedded in social media systems; conversely, one or more social media systems may preferably be embedded in one or more CCFs. There are many other potential uses for a contingent commitment facility, including facilitating international cooperation to address major complex problems such as global warming. In widespread use, CCFs may create an enormous increase in the common good, through the simple power of saying â&#x20AC;&#x153;maybeâ&#x20AC;?.

author Marc Groz Marc M. Groz is an inventor and financial executive with a special focus on cyber and systemic risks. A financial innovator and social entrepreneur with six issued patents, his inventions have many applications to financial markets, gaming, and cooperative problem solving. As Managing Member of Right Risk, he brings a unique experience profile to his practice of risk consulting, having served in senior risk, technology, and research roles for well-known hedge funds and a multi-billion dollar asset manager.

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are you ready for Solvency II?

by Sol Steinberg According to a recent survey completed by State Street, 36% of respondents say they feel like asset management companies are unprepared for providing the level of data insurance clients require. Furthermore, even if asset managers are prepared to provide reports, 41% say that they still donâ&#x20AC;&#x2122;t believe the asset manager will be able to do it on time. Insurance clients are not the only ones with doubt. Fund managers are also concerned about their strategic positions being leaked. 31% of respondents thought that alternative managers will be very reluctant to share important and commercial data in light of the leaking concerns. Further, 65% believe that fund of funds will be adversely affected by Solvency II. This concern is due in part to the reality that insurers will have to pay higher capital charges under Solvency II, which may require them to reduce their exposure dramatically to alternative asset classes. Overall, 68% of insurance executives and fund managers believe that the pressure of Solvency II on insurers will lead to them placing a greater focus on investment strategies that provide more predictable and uncorrelated returns. All of these concerns are the result of the significant reporting requirements included in Solvency II and in IFRS. Not all firms are prepared to meet each requirement yet, and some rules are still to come. Some of the implementing technical standards (ITS) have yet to be published and there are 12 remaining to be validated. Additionally, data quality and governance issues have been identified as critical to Solvency II transparency objectives; however, issues with data quality are often discovered late in projects. This has an impact on time to publication for reporting and can also change the information that is produced from a given project. On the insurance side, there are three sets of challenges regarding Solvency II implementation operational, automation related, and strategy related. Operational challenges include changing processes to ensure compliance, which in turn adds pressure to communication and existing IT systems. Solvency II has smaller reporting windows, and audit trails, training, and monitoring all must fall in line within those compressed timelines. Additionally, on the automation side, manual ad-hoc processes are often used for trial runs which makes it difficult to repeat processes.

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Going forward, the increased frequency of reporting and the volume of data will be incompatible with manual processes or maintaining spreadsheets. Finally, firms will have to think strategically about how they implement compliance. Future needs will include asset/liability projections, liquidity monitoring and specific stress tests. For asset managers, the challenges are greater. Transparency, increasing data demands, adaptation issues, and proactive investment each carries separate concerns for management to consider. Solvency II creates the need to provide look through data for funds, which is potentially resource intensive and may require a change in format. Regulators are also asking for more granularity and a greater focus on data quality. Alongside this will come cost concerns for sourcing, augmenting and supplying timely and accurate data. Solvency II doesnâ&#x20AC;&#x2122;t exist in a vacuum, so asset managers will also have to ensure that this reporting falls in line with other reporting required under AIFMD, EMIR, UCITS or MiFID II as applicable. There are some emerging trends in terms of how people are working to solve these common challenges. On the insurance side, there is an increased interest in illiquid assets or asset classes that have lower capital requirements such as secured loans. Long dated illiquidity is also rewarded in the regulations, thus a greater focus on illiquid asset classes or assets with fixed cash flow profiles. When it comes to hedging, rolling shortdated derivatives are no longer acceptable, so we may see a greater use of swaps in order to replicate the risk-free rate. Going forward, asset managers will need to understand how risk is measured from the perspective of the insurer in order to be responsive and continue winning business. This may mean developing new strategies to maximize return on regulatory capital, and also to provide products with greater capital efficiency. Timelines of reports will also be critical for both clients and regulators.

author Sol Steinberg OTC Markets Subject Matter Expert Sol Steinberg is a OTC Markets Subject Matter Expert that specializes in Risk Management, Regulation, Market structure, Collateral, Valuation, Financial Technology Systems, and commercialization efforts. Sol is the founding principal of his firm, OTC partners. OTC partners is a boutique value add firm that specializes in research, content, and business development. Before starting OTC Partners Sol was a senior executive at the worldâ&#x20AC;&#x2122;s leading clearing house LCH.Clearnet. Sol also spent nine years on the buy side and Citi, performing product development, risk management, and valuation for the OTC markets.

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PRMIA Risk Standards of Practice (RSoP)

by Julian Fisher This is a call to arms - PRMIA Needs you! The PRMIA RSoP Committee is looking to recruit and build on its PRMIA Standards of Practice Working Group, a volunteer-lead group made of senior banking, insurance, and asset management practitioners. PRMIA’s RSoPs are an articulation of the Recommended Minimum Sound Practice in risk management expressing risk management Outcomes that should be achieved and the Minimum Best Practices required to achieve these risk management Outcomes.

what prompted the initiative and the current state of the risk industry? What started out as a nascent “industry” first enshrined by the Basel Committee on Banking Supervision in 1988 as Basel I, the practice of risk management has now become just that, a practice. Due to the recent spate of financial crises there has been an increase in Regulatory and Public demand for Financial Institutions around accountability, comparability, and transparency. The practice of risk management has risen in prominence with dedicated statements around risk, risk appetite and controls finding prominence in financial statements. Illustrating the ever evolving nature of risk management, in the US, the OCC Heightened Expectations1,

has been transformed from one of “Heightened Expectations” to stated objective measures and criteria for compliance with the Minimum Standards of risk management. In tandem the Federal Reserve requires the US and, in 2017, Foreign Banking organizations with more than $50bn in assets to describe their risk management frameworks as part of the Comprehensive Capital Analysis and Review (CCAR). Under the ISO banner, ISO 31000 & ISO/IEC 31010:2009, risk management & assessment techniques also provide principles, framework and a process for managing risk that can be used by any organization regardless of its size, activity or sector.

1 / OCC Guidelines Establishing Heightened Expectations for Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches: Integration of Regulations

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While on the surface these existing Standards of Practice for the risk industry encourages broad supervisory standards and guidelines and recommends descriptive rather than prescriptive, statements of best practice in banking supervision. These rely on member authorities and other nations to implement them through their national systems. Compared to both the Actuarial Standards of Practices and Accounting Standards of Practice, which have been honed over many decades, the amalgamation of existing risk standards highlights that the existing risk standards are anything but standard.

What are PRMIA’s Risk Standards of Practice (RSoPs)? PRMIAs goal is to closely align the RSoPs with the syllabus of the PRM™ Designation. As a result, each RSoP is explicitly linked to its corresponding chapter in the PRMIA PRM Handbook and is based around Market, Credit, Operational, Liquidity and other risks. • The RSoP outlines WHAT needs to be done and what outcomes need to be achieved in order to satisfy Recommended Minimum Sound Practice in Risk Management; • The PRMIA PRM Handbook articulates HOW to execute risk management activities that will achieve outcomes that satisfy Recommended Minimum Best Practice. By design, the RSoPs will provide further on the job guidance to PRM Holders - and aspiring PRM Candidates - in the performance of their duties. While the PRM designation is a validation of skills, adding credibility to the work performed by an individual and adherence to the RSoP will reinforce the individual’s commitment to improving the industry they are part of. In order to facilitate comparability of adherence to the RSoP risk management Objectives and Outcomes, an RSoP benchmarking template has been designed that enables participating organizations to: • Internally benchmark their adherence to the SoPs by business area, geography and other parameters; • Externally benchmark their adherence against similar organizations via a hosted PRMIA service that will provide full anonymity.

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what do the PRMIA RSoPs look like?

Authoritative Sources of Risk Management Guidance

The manner in which RSoPs fit within the existing PRMIA offering set is illustrated below:

• Detailed guidance for Professional Risk Managers articulating HOW to execute risk management activities that will achieve outcomes that satisfy Recommended Minimum Best Practice. • Comprised of individual subject area oriented:

PRM & ORM Handbook Chapters

Authoritative Sources of Risk Management Guidance

Recommended Minimum Best Practice aligned to guidance within relevant PRM Handbook Chapter

Guidance within PRM Handbook chapters aligned to Minimum Recommended Sound Practice within associated RSoP(s)

Standards of Practice “WHAT” Key Regulatory Frameworks

• Key regulatory frameworks that are mandatory in a sizeable majority of jurisdictions where PRMs are engaged.

Individual Requirements Traced to and consolidated within

All terms used within PRM Guidance (Handbook & RSoPs) defined once in Glossary and used consistently across all guidance

• e.g., BCBS Principles for effective risk data aggregation and risk reporting

Key Regulatory Frameworks

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• Comprised of individual:

Statements of Recommended Minimum Sound Practice

• Individual frameworks may not be mandatory in some jurisdictions but may still be referenced as authoritative sources of guidance for best practice.

• Key requirements from Industry Best Practice. e.g. COSO ERM, COBIT.

• Definitive statements for Professional Risk Managers of WHAT needs to be done and what outcomes need to be achieved in order to satisfy Recommended Minimum Sound Practice.

Risk Management Glossary Individual Requirements Traced to and consolidated within

• Common definitions of terms used throughout all guidance for Professional Risk Managers.

In addition, the components of a Standard of Practice are: Transmittal Memorandum Background Information and version control relating to the SoP

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Concise top level document that details background of the SoP

• Description of key issues related to the development, or revision, of the SoP

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Version and Impact control

• Contains information on changes made between versions including links to changes in definitions, impacts from associated KRIs, change in regulations, best practice, PRMIA PRM Handbook or other

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Aligned with PRMIA PRM & ORM Handbook

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Definition of Standard of Practice for each Risk Framework component.

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Defines Pre-Conditions that need to be met in order to ensure that it is possible to achieve the recommended minimum best practices. PreConditions are specific dependencies on outcomes of activities that are executed in accordance with other (precursor) Standards of Practice.

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A single, consolidated central repository for all definitions, bibliographies, best practice and regulatory edicts

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Ensures that all SoPs are kept in sync with changes to definitions, best practice, revisions to related SoPs etc.

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Related bibliography and related SoP links applicable to SoP are compiled in a secondary document attached to each SoP.

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Definitions of terms are published as a single Risk Management Glossary SoP that is relied on by readers of all guidance documents

• Background Information on SoP

Standard of Practice , Scorecard & Benchmark Definition of Standard of Practice for individual Risk Framework Components Scope, Effective Date of SoP • Defines the scope of the SoP and the date from which the current SoP is active • Defines retrospective impact of changes to prior SoP Issues to be Addressed and Recommended Minimum Best Practice • Pre-Conditions / Dependencies • Provides the appropriate, best practice analytical framework for completing services/ duties which fall within the scope and purview of the SoP • Analysis organized into major topics or issues involved in rendering services or discharging duties within the scope of the SoP Supporting Appendices • Provides additional background on the SoP and prior issues • Describe current or alternative practices related to the SoP • Summary of all comments raised by PRMIA members in the SoP development process and their disposition by the drafting committee

Communication & Disclosure • Communications or disclosures pertinent to the subject of the SoP and any applicable limitations • References specifics within Code of Conduct including suggested actions if deviating from guidance in the SoP Internal Scorecard & External Benchmark • Internal scorecard used to assess organization’s adherence to the Objectives and Principles of the SoP • External benchmark used to compare level of adherence to the SoP against other, similar, organizations

Supporting Information Definitions • Single source contains the universe of definitions used in SoPs • Definitions related to each SoP are extracted from this single source Related SOPs • Indexed library of all SoPs and their interdependencies • Index dynamically updates interrelated SoPs when changes are made at the constituent level and publishes to members after approval by SoP committee(s)

Related Bibliography & Regulations • Indexed library of all bibliographies including local and global regulations • Index dynamically updates interrelated SoPs bibliography section and publish after approval by SoP owners

Each Risk Management Outcome and Objective is linked both internally and externally to other Risk Management Objectives as illustrated below for the RSoP around Key Risk Indicators: SOP 5 – Risk Appetite RMO 5.0X Define Risk Appetite

SOP 2 – KRIs RMO 2.01 Define & Maintain KRI Framework

SOP 6 – RCSA RMO 6.0X Assessing Control Effectiveness

SOP 6 – RCSA RMO 6.0Y Scenario Analysis

SOP 2 – KRIs RMO 2.02 Define/ Select KRIs

SOP 2 – KRIs RMO 2.03 Set KRI Thresholds

SOP 2 – KRIs RMO 2.04 Monitor & Reassess KRIs

SOP 4 - Capital Modeling for Operational Risk RMO 4.0X Capital Modeling BEICF

SOP 5 – Risk Appetite RMO 5.0Y Set Update Risk Appetite Level

SOP 2 – KRIs RMO 2.05 Identify & Investigate KRI Exceptions

SOP 2 – KRIs RMO 2.06 Notify & Escalate KRI Exceptions

SOP 3 – Operational Risk Losses RMO 3.0X Loss Event Investigation & Root Cause Analysis

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what form do RSoPs take? Accounting and Actuarial bodies use their SoPs as detailed rules by which all members must adhere, with disciplinary action for those who do not. They are used as the yardstick by which local regulators & 3rd parties judge work conducted by members, and deviation can be followed by civil and criminal penalties. PRMIA is proposing that, initially, SoPs are rules by which all practitioners should abide. RSoPs are used as the yardstick by which local regulators & 3rd parties judge work conducted by risk managers but do not carry either civil or other penalties for deviation.

what are the benefits of a SoP? The RSOPs identify what the risk manager should, and must, consider, document, and disclose when performing risk management duties and serve to assure the public that risk managers are professionally accountable for the work they perform. RSoPs provide practicing Risk Managers with a basis for assuring that their work will conform to appropriate practices. Standards protect the public by: • Indicating, for various areas of risk management practice, appropriate procedures, techniques, and approaches. This enhances the public’s trust in the credibility and completeness of Risk Management work performed; • Providing a means by which the many separate elements that make up the risk management practice can be reviewed and updated on a regular basis so that the practice remains current; • Furnishing criteria for evaluating risk management work; • Providing a basis for discipline in those instances in which standards are not adhered to. For risk managers, standards confer major benefits as well, by: • Providing guidance, particularly in practice areas that may be somewhat unfamiliar; • Giving strong evidence to any interested observer that the profession serves the public in an effective and responsible way; • Offering evidence of appropriate professional performance, which constitutes a defense in any civil or professional disciplinary action. 038

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Standards of Practice also serve to further assure regulatory authorities that they can depend on the risk management profession to act effectively in the public interest. Written standards of practice, coupled with written provisions for disciplining members, show that a profession governs itself and takes an active interest in protecting the public.

current status of PRMIA’s Risk Standard of Practice initiative - a call to arms At present, several Operational Risk RSoP prototypes have been developed and are in a trial state at several disparate types of institutions. Pending final analysis, both the RSoPs and the benchmarking tools will be “reformatted to fit”. Once the drafts have been finalized, they will be made available to all PRMIA members for comment. Comments will be a matter of public record and will be documented and acted upon by each RSoP Working Group under the “supervision” of the PRMIA RSoP Standards Committee. The PRMIA RSoP Executive Steering Committee is in the process of being formed and will be comprised of senior financial institution CROs as well as regulators from around the globe. In the near term, we are seeking Operational Risk practitioners and SMEs to participate in the development of approximately seven new Operational Risk RSoPs, with Market and Credit Risk RSoPs slated to start early next year. It is anticipated that the time commitment per individual for the development of each RSoP should not exceed 30 hours. Each contributor will have their name prominently displayed within each RSoP and will be involved in each further iteration going forward. If you are interested in participating in this initiative, you can find more information on the Working Groups and how to participate by accessing the following link. The RSOP(II) on Key Risk Indicators can be accessed at this link.

author Julian Fisher Julian Fisher has wide-ranging experience in Risk Management, Finance and Insurance and has lectured extensively around the world on topics ranging from Governance, ERM, Credit Risk, Operational Risk, and Ethics. He is currently an Executive Director at Crest Rider, Inc. where he aids financial service clients in developing and implementing cuttingedge risk management solutions designed to comply with an ever-increasing number of international regulations. He has also held senior roles in New York and London with PwC, Capco, Reuters and Deutsche Bank and sits on several Industry Risk Steering Committees. Intelligent Risk - December, 2015

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new PRM™ accredited program profile

by Clement Wong One hundred years ago, the University of Hong Kong http://www.hku.hk (HKU) was founded. Our long and illustrious heritage has placed us at the vanguard of innovations in teaching, learning and research. Over the past century, HKU has drawn first-class educators and thought leaders from all corners of the globe. These scholars have instilled in our students a passion for leadership with a genuinely global perspective. This longevity – unrivalled in Hong Kong – arms the Faculty of Business and Economics http://www. fbe.hku.hk with the maturity, the knowledge, and the credentials to realize our mission. The Faculty of Business and Economics provides an intellectual infrastructure that facilitates innovative scholarship that addresses the demands of the new Asia-led economy. Our emphasis may be in Asia, with an eye on China, but our alumni are not confined by the boundaries of a city, or a region. Indeed, generations of our graduates have gone on to make an impact in industries worldwide. We strive to not only educate first-class business leaders for the global economy and the 21st century but to nurture individuals who make a positive difference in the world. We foster competence, confidence and responsibility. These are the qualities that characterize pioneers in every walk of life. The Faculty of Business and Economics was created through the amalgamation of two schools -- the School of Business and the School of Economics and Finance. Forming an alliance of excellence, the Faculty of Business and Economics takes an entrepreneurial approach to meeting the challenges of a rapidly changing economic and business environment by drawing together the strengths of the two schools. The School of Business http://www.business.hku.hk equips students with the vision and practical tools necessary to become successful business leaders in Hong Kong, Greater China and in the region. The School of Economics and Finance http://www.sef.hku.hk provides a firm grounding in both theoretical and applied aspects of economics, allowing students to analyze how business and policy decisions are made in a dynamic world.

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about the BSc. Quantitative Finance programmes

The BSc (QFin) is an enhanced version of a regular finance programme. Besides offering a solid foundation in major areas of finance such as microeconomics, macroeconomics, corporate finance, and investment as a regular finance programme does, BSc (QFin) equips students with the requisite quantitative skills needed in financial analysis such as statistics and programming. Besides, the programme broadens studentsâ&#x20AC;&#x2122; perspectives by introducing them to advance topics in finance such as financial modeling, risk management, financial engineering, and market regulations. The programme strikes a delicate balance between quantitative skills and market knowledge. Its curriculum is designed to train all-rounded financial managers who can relate theories to practice and know how to apply quantitative skills to real world problems. To nurture studentsâ&#x20AC;&#x2122; soft skills and market acumen, the programme puts in place a range of enrichment activities in collaboration with practitioners in the financial market, such as Round Table with Practitioners, Executive Mentoring Scheme, Bloomberg workshops, and international field trips to financial centers such as New York, London, and Zurich. The programme also provides amply room and flexibility for students to take free electives and to acquire additional knowledge in specific areas through minor or second major.

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learning opportunities In the current environment risk education is not just a choice, it is a necessity. PRMIA provides open enrollment and customized classroom training, using leading academic instructors and practitioners who are experts in their fields. Please contact us if you are interested to learn more about our customized classroom training programs.

UPCOMING CLASSROOM COURSES ARE LISTED FOR YOU BELOW. OPERATIONAL RISK MASTERCLASS: MEASUREMENT, MANAGEMENT, AND LEADERSHIP Featuring Russell Walker New York / December 7-8, 2015, 8:30 A.M - 5:30 P.M. Operational risk has grown in importance. New regulation, increased business complexity, and emerging technology contribute to a firmâ&#x20AC;&#x2122;s operational risk and suggest that this type of risk is a force that will continue to increase in size and significance. In this Master Class on Operational Risk, we will explore the features that make operational risk challenging not just in measurement and management, but also in leadership. Through real-world case studies, we will examine how operational risk challenges firms unexpectedly and how it can inevitably result in more regulation and reputational harm. We will explore operational risk in financial services and how it is manifested differently in banking and insurance... More details here.

CLASSROOM PREPARATION COURSE: OPERATIONAL RISK MANAGER CERTIFICATE Featuring Ariane Chapelle London / December 15-17, 2015, 9:00 A.M - 5:00 P.M. Operational risk is defined broadly and as a causal risk, the risk of loss due to failures in people, processes, systems or external events. It underlies many other risks, in particular regulatory and reputation risks, which are fundamental to the business model for financial institutions. It has become a very costly risk for firms which have not managed it well. It is a discipline which continues to develop rapidly in sophistication and relevance to business decision making. More details here.

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submission guidelines CALL FOR ARTICLES Article submissions for future issues of Intelligent Risk are actively invited. Articles should be approximately 1,000–1,500 words, single spaced, and cover a topic of interest to PRMIA members. Please consult the submission guidelines located at the end of the publication prior to submitting your article. Please send all article submissions that you wish to be considered for publication to iRisk@prmia.org. Chosen pieces will be featured in future issues of iRisk, archived on PRMIA.org, and promoted throughout the PRMIA. community.

I-RISK SUBMISSION GUIDELINES Follow these instructions regarding the format of your articles and references. Article Submission - Please send all article submissions that you wish to be considered for publication to iRisk@prmia.org File Format - Please prepare your work using Microsoft Word, with any images inserted as objects into the document prior to submission. Abstract - Please present a brief summary or abstract of the paper on the page following the title page. Author Biography - Please include a biography, not exceeding 150 words, for each of the contributing authors listed. All biographies must be included at the end of the article. Author Photo - Please provide a professional photograph to be included with your article. The photo must be submitted as a separate file in jpeg or tiff format. Exhibits - Remember to attach all elements relevant to the paper (tables, graphs, charts and photos) on separate and individual pages at the end of the article. Please denote all tabular and graphical materials as Exhibits, and designate them using Arabic numerals, successively in order of appearance in the text. Exhibit Presentation - Please ensure that tables and other supplementary materials are organized and presented consistently throughout the paper, because they will be published as is. You may submit exhibits produced either in color or black and white. Use the exact same language in consecutive appearances; indicate all bold-faced or italicized entries in exhibits; arrange numbers consistently by decimal points; use the same number of decimal points for the same

types of numbers; center headings, columns, and numbers correctly; and incorporate any source notes when required. Consistency of fonts, capitalization, and abbreviations in graphs throughout the paper is required, and all axes and lines in graphs must be labeled in a consistent and coherent manner. Paste all graphs into Word documents as objects, and not as images, allowing access to the original graph. Please supply source materials for graphs such as Excel files. Equations - Please present equations on separate lines. All equations must be aligned with the paragraph indents, but not followed by any punctuation. Use Arabic numerals at the right-hand margin to number equations consecutively throughout the article. Use brackets to indicate all operation signs, Greek letters, or other such notations that may be ambiguous. Reference Citations - In-text citations of authors and works must be represented as: Smith (2000). Use parenthesis for the year, not brackets. Similarly, references within parentheses must be represented as: “(see also Smith, 2000).” References List - A reference is a source that is actually cited in the text. Please formally list only articles previously cited, using a separate alphabetical references list at the end of the article. Author Guidelines - PRMIA categorically values literary excellence in selecting articles for publication. To enhance clarity and coherence, we urge the use of simple sentences comprising of a minimal number of syllables per word.

Please follow these recommendations in the interests of meeting PRMIA’s publication standards, and to accelerate both the evaluation and editorial process. The review process will take up to 4-8 weeks. The author will receive articles due for revision, as well as those while accepted, departs in large part from these guidelines. Finally, PRMIA reserves the right to return to an author for reformatting purposes, any article, which is accepted for publication that deviates from the aforementioned standards. The editors always reserve the right to make further changes to your work for consistency and coherence.

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