INTELLIGENT RISK knowledge for the PRMIA community
December 2017 ©2017 - All Rights Reserved Professional Risk Managers’ International Association
PROFESSIONAL RISK MANAGERS’ INTERNATIONAL ASSOCIATION CONTENT EDITORS
INSIDE THIS ISSUE
Steve Lindo Principal, SRL Advisory Services and Lecturer at Columbia University
Dr. David Veen Director, School of Business Hallmark University
Nagaraja Kumar Deevi Managing Partner | Senior Advisor DEEVI | Advisory Services | Research Studies Finance | Risk | Regulations | Analytics
SPECIAL THANKS
FIND US ON
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@prmia
The regulation risks of crypto currencies - by Adam Litke
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PRMIA Chapter Profile – Washington DC
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7 key components of a sound model governance framework - by Rad Lukic
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The future of CCR for non-centrally cleared OTC derivatives - by Lorenzo Colonna
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The risk conversation evolves at the EMEA Risk Leader Summit - by Kraig Conrad & Alexandru Voicu
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Procyclicality remedies for the CCP’s initial margin requirements - by Elena Goldman & Xiangjin Shen
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PRMIA risk leader initiative
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The unintended consequences of cybersecurity regulation by Bogdan Botezatu
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On regulating crypto currencies, tokenised assets, and ICOs by Stefan Loesch
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The evolving regulatory framework on cryptocurrency: what lies ahead? - by Vivek Seth
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Regulations upgrade in China’s equity market by Qi Lu & XinXin Li
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Energy banking regulations: the good, the bad, and the ugly by Ajay Prakash
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Has regulation changed risk management? by Grigoris Karakoulas
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To FRTB and beyond - by Sanjay Sharma
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PRMIA Canadian Risk Manager of the year & Canadian risk forum
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PRMIA partner news - by Andy Zhulenev
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letter from PRMIA leadership
Justin M. McCarthy Chair, PRMIA
Kraig Conrad CEO, PRMIA
welcome to this edition of Intelligent Risk It is our pleasure to extend greetings for a wonderful holiday season. We wish our global community health, happiness, and prosperity in 2018! Your mission-focused, member-led organization this last quarter furthered progress on our strategy with enhanced regional events, increased volunteer participation, and new Board Directors. The Canadian Risk Forum, EMEA Risk Leader Summit, and combined Washington DC and New York fall Summit received high marks while helping to advance risk practice amid challenges to business models and traditional risk team structures. These events are only possible because of the tireless dedication of committed volunteers who well frame these challenges for debate and insightful discussion. We thank them for their leadership on behalf of the Board of Directors and our community. A record level of well-qualified practitioners raised their hands to help fulfill our mission through this year’s call for volunteers that attracted a diverse talent pool by tenure, gender, region, and industry. This response level affirms confidence in the great things PRMIA is doing in your service and for our profession. And, the new class of Directors builds on our great leadership team to ensure strategy and resources meet the current and future needs of the profession. Our Board defines strategy. Our Global Committees, Chapter leaders, and volunteers make it a reality.
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David Coleman
Nirakar Pradhan
Lakshmi Shyam-Sunder
Tom Wilson
Managing Director, Risk Management, European Bank for Reconstruction and Development
Head of Investment Control, Risk Management, Generali Investments Europe S.p.A
Vice President and Group Chief Risk Officer, World Bank
Chief Risk Officer, Allianz
It is an honor to add such strong and highly qualified Directors to the Board. PRMIA membership should feel extremely confident that their elected leaders are among the most committed risk practitioners from around the world. We would like to thank outgoing PRMIA Board members Wilson Fyffe, President, Amplios Consultants Pte Ltd.; Pym Maurois, Senior Manager, Finaxium Consulting; and Robert Reitano, Professor of the Practice in Finance, Brandeis International Business School, for their years of dedicated service at the Chapter, global committee, and Board of Directors level. Their involvement in PRMIA is an enduring legacy that will continue well into the future. On behalf of a grateful association, thank you.
join your peers. volunteer. As we do with each edition of Intelligent Risk, we invite you to be join us on our journey to serve the global risk profession. You are why the organization exists. Like the many who raised their hands this year to volunteer, please add your voice to dialogue on the future of PRMIA.
Justin McCarthy Chair, PRMIA
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Kraig Conrad Chief Executive Officer, PRMIA
editor introduction
Steve Lindo Editor, PRMIA
Dr. David Veen
Nagaraja Kumar Deevi
Editor, PRMIA
Editor, PRMIA
welcome to the last Intelligent Risk issue of the year The December 2017 issue of Intelligent Risk has special significance, as it is sponsored by Bloomberg and contains articles on the Future of Financial Services Regulation. We received an admirably diverse assortment of perspectives and topics related to this intensely debated theme. This issue features articles that focus on: Cryptocurrency, Remedies for the Initial Margin Requirements of CCPs, Regulations Upgrade in China’s Equity Market, Model Governance, and To FRTB and Beyond. In addition, it includes a special article from Bloomberg on Cryptocurrency. All of the articles share topics with a specific focus on the future of regulation. We hope you enjoy reading these thoughtful and articulate pieces contributed by PRMIA members as much as we did editing them.
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the regulation risks of crypto currencies
by Adam Litke It has often been said that when a regulator sees something new, he wants to find a way to regulate it. In the case of cryptocurrencies, this is a well-placed desire since, as currently structured, these currencies make a number of current regulatory practices impossible as well as taking away some of the flexibility of central banks in managing economies. We should start by noting that cryptocurrencies really are currencies and not, as some would have it, commodities. They are not consumable and have no inherent value of their own independent of what people are willing to exchange for them. On the other hand, cryptocurrencies have a few properties that conventional currencies don’t have. They are not issued by a government or central bank and, for the most part, they cannot be traced. Of these two properties, untraceability is the most commonly cited problem as it means that cryptocurrencies can be used in a wide range of criminal activities. Tax evasion, money laundering, bribery, and paying for illegal goods and services all become quite simple if nobody can say where the money came from or where it went to. While all of these things are bad from a legal and societal perspective, only tax evasion is a truly serious issue from the position of the financial system. If too much of the economy moves out of the realm of government oversight, then tax revenue will plummet. To make up the revenue, governments will have to change tax policy. In and of itself, changing tax policy is not a bad thing, but an unintended sudden change is bad. Businesses and households make long term plans based on how they think they will be taxed. We have seen many times that uncertainty over government policy tends to stifle long term investment and cause recessions and this time will be no different. This is, of course, only a one time change so it is not really fundamental even if it does cause a temporary recession. The larger problem for the financial system is that currency is independent of any central bank. This has grave implications for both liquidity risk and monetary policy. Banks are not just in the business of taking deposits at low rates and lending the money back out at a credit spread. They are also in the business of liquidity transformation, turning short term deposits into longer term loans. This is one of the reasons monetary policy works. When the central bank cuts short term rates the yield curve steepens and the extra interest rate spread banks make from making term loans is a huge incentive to put money to work even when credit conditions are dicey.
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What happens if a large percentage of bank deposits are denominated in a cryptocurrency? In this case, the central bank is stuck. Lowering overnight rates in the local currency becomes meaningless. Raising overnight rates also has no impact. The same is true of quantitative easing. If most debt is denominated in a cryptocurrency, then printing money to purchase this debt only debases the local currency. The basic central bank tools for cushioning recessions or dampening inflation have been rendered useless. The same phenomenon that makes it impossible to use monetary policy also causes problems for liquidity risk management. Most troubled banks are not yet bankrupt. Their assets are still worth more than their liabilities. When depositors become worried about the condition of a bank, they pull their money out. Now the liquidity transformation that was so profitable becomes a death spiral. In a conventional economy the central bank will step in, lending to the bank to keep it solvent until it can either regain the confidence of the market or be sold or unwound in an orderly fashion. In a cryptocurrency economy this option is not available and we end up with a classic run on the bank. Depositors can be ruined and, if enough banks get in financial difficulty, a run on the bank can become a run on the economy leading to a major depression. It is pretty clear that regulations of some sort are in order. The most obvious and most likely of these is a ban on taking deposits in any cryptocurrency and the regulatory treatment of cryptocurrencies as commodities. Banks would still be allowed to trade them and they could still be used for payments, but they would not be allowed to become a primary store of value. Enthusiasts will explain that cryptocurrencies will simply replace the need for banks and that central banks will no longer be necessary, but it is clear that regulators and central banks have reasons to want to prevent this.
author Adam Litke Adam Litke is the Head of Risk Solutions for Bloomberg. He is responsible for developing Bloomberg’s strategy around risk models and software. Prior to this Adam was the head of Market Risk for the Securities and Investment Group of Wells Fargo and head of Market Risk for Wachovia where he managed market risk activities including quantitative risk management, counterparty risk modeling and direct management of market risk. Before that Adam worked for Barclays Bank, PLC as the head of Market Risk in the Americas and head of Market Risk for Global Financing. Adam also served as the Global Head of Market Risk for Swiss Re Financial Products, and spent several years in various management roles with BNP Paribas. Adam is a trustee of the Georgia State University Risk Management Foundation and is a former advisory board member for the GSU masters program in mathematical risk management. He is also a past chairman of the Market Risk Program Committee for the New York Chapter of PRMIA.
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PRMIA Chapter Profile – Washington DC Membership composition - Washington DC is one of the oldest PRMIA chapters, serving a professional community comprising federal government agencies, international organizations, government contractors, legal profession, higher education, and non-profits. As a result, PRMIA Washington DC’s membership is unusually diverse and constantly changing. A sizeable number of chapter members come from other cities but conduct much of their business in Washington DC. In addition, recognizing the US capital’s academic pre-eminence, PRMIA has cultivated a student chapter at George Washington University. Chapter Leadership - In keeping with its membership’s high-profile and changing pool of professionals, the PRMIA Washington DC chapter has had many distinguished volunteer leaders over the years. The current Regional Director, Vladimir Antikarov, has held the position for the last 4 years. Events - The chapter’s event calendar seeks to capitalize on the unique pool of expertise and perspectives in its professional community, with a focus on bringing together industry and policymakers to exchange views on topics of common interest. Topics covered in recent events include financial services regulation, market structure and liquidity, infrastructure security and risk talent. Venues which have, and continue to support the chapter’s events, include GWU, the Federal Deposit Insurance Corporation, and several prominent law firms.
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Annual Financial Services Risk and Regulatory Forum The highlight of the chapter’s event calendar is an annual Financial Services Risk and Regulation Forum which takes place during October-November. Past-year themes have included Implementation Issues of Regulatory Reform, Understanding and Planning for the New Liquidity Landscape and Changing Market Structures. The theme of this year’s event, which took place on November 8th with over 65 attendees, was Redefining Financial Services Regulation. The keynote speech was given by Jared Sawyer, Deputy Assistant Secretary for Financial Institutions Policy at the US Treasury, which is taking the lead in re-examining the current regulatory framework of the US financial sector. Following the keynote speech, three panel sessions featuring distinguished speakers from government, industry and academia, discussed the topics of Reducing the Regulatory Burden, Too Big to Fail and Regulating Trading Activities. The event closed with a networking cocktail. Prior to the forum, an invitation-only lunch was held for 25 senior government and private-sector leaders, who held a closed-room discussion on the themes of global regulations and systemic risk. The venue was graciously provided by law firm Steptoe and Johnson. Plans are already underway to hold a follow-up invitation-only lunch in May 2018.
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7 key components of a sound model governance framework
by Rad Lukic Throughout my career in credit analysis, I have been fortunate to deliver and collaborate on a range of risk and capital related solutions that have helped manage the exposure of financial and credit lending institutions worldwide. Through these client engagements, there have been many insightful lessons learned – especially pertaining to Model Governance -- so much so, that my team and I have developed a checklist of 7 key components that should be considered and robustly documented in a sound model governance framework.
1. Development Model risk management begins with robust model development, implementation, and use. Regulatory guidance recognizes that applies to all material models model development is not a routine technical process, but one where the experience and Development judgment of the developers, as much as their technical knowledge, greatly influence the Implementation appropriate selection of model components. But from a model governance perspective, Validation it’s vital that every step of the development process is fully documented. That includes Approval the data development set, where there should be rigorous assessments of data Modification quality and relevance, as well as performance testing which is an integral part of model development. Regulatory guidance suggests Retirement that model testing should include checking the model’s accuracy, demonstrating that the Model Inventory model is robust and stable, assessing potential limitations, and evaluating the model’s behavior over a range of input values. We should also assess the impact of assumptions and identify situations where the model performs poorly or becomes unreliable. All this information should be captured in the Model Development Documentation to be reviewed by your Validation Team.
Model Governance Policy
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2. Implementation The key to the implementation process is to generate consistent results. We should note that the development, implementation and use phases of the model life cycle are typically handled by different groups within a company, with the potential for risk increasing as the model is passed between different stakeholders. This is where model implementation documentation, including User Guides and operating procedures, are of key importance to help mitigate that risk and reduce key person dependencies. According to OCC 201112 / FRB 11-7 Supervisory Guidance, Model Development, Implementation, and Use are closely linked and model risk management should include disciplined model implementation processes. The line between development and implementation needs to be seamless, allowing the quality assurance process to uncover any errors even before implementation starts.
3. Validation It is vital to effectively challenge your models at least on an annual basis. That includes a qualitative validation, where model design and methodologies are examined through an independent review of the conceptual soundness of the model. A quantitative validation could include a comparison of model prediction against subsequent real-world events (back-testing, out-of-sample-testing, etc.) Another example is where the model output will be benchmarked to the output of an alternative model with any divergences investigated. Validations should be conducted internally through a separate and independent group or outsourced to a qualified third party.
4. Approval When considering the approval process you need to consider the model governance roles and responsibilities.
Model Owner Model Oversight Committee
Model Developer
Material Models Model Validation Group
Model Implementer Model Advisory Team
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While we have identified six roles, conceptually, the roles in model risk management can be divided among ownership, controls, and compliance. The checks and balances provided by the Model Advisory Team, Model Validation Group and Model Oversight Committee ensure a rigorous approval process. A fundamental component for each of these roles is their independence, and it is important that reporting lines and incentives be clear, with potential conflicts of interest identified and addressed. Certain regulatory guidance also suggests that senior management is responsible for reporting to the board on significant model risk-- from individual models and in the aggregate -- and on compliance with policy. Board members should ensure that the level of model risk is within their tolerance and direct changes/modifications where appropriate.
5. Modification The most common breakdown in a model governance framework is the lack of documenting and testing on model modifications. As we have found when we conducted validations with numerous clients, it’s quite common that model “enhancements” are undocumented and informal. In addition, there are often no strict limits in place for changes made to models once they are approved. Meanwhile, regulators expect institutions to have a formal plan for the ongoing performance and risk monitoring as well as robust changecontrol processes. These policies should detail the plan of action for assessing the model’s continued effectiveness (this is, in essence, a formal model validation policy) and limiting access to changes postapproval.
6. Retirement An underrated component of the model governance framework is model retirement, but I want to emphasize that ongoing monitoring needs to be done over the life of the model, and what is considered the best or “Champion” model can change over time. As existing models are replaced, resources should be focused on the “Champion” and “Challenger” models, and those models that do not meet that criteria should be retired.
7. Model Inventory You definitely learn more about an institution’s internal risk rating system when you review their model inventory – the strengths and more importantly where the gaps exist. So a model inventory review is the logical starting point where you would review the overall model governance framework. A comprehensive inventory of all models used within a bank is an important starting point that is often missing or lacking. This should include details on scope of application and any restrictions on usage. I want to mention that model inventory is not a one-time exercise, and there should be a process to ensure model inventory is tracking the models by materiality, key dependencies, or assigned model risk scores.
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conclusion In the current environment of heightened regulatory scrutiny, the need for a sound model governance framework is more crucial than ever. We believe that focusing on these seven components covering all phases of a model life cycle -- development, implementation and on-going performance and risk monitoring -- provides a roadmap towards avoiding the most frequently-seen, critical regulatory concerns on Model Governance. We note that compliance of the models with the upcoming FASB CECL requirements may heighten the scrutiny around model risk governance. Risk management groups will need to start planning for validation procedures around the new CECL models, including validation of their forecasting accuracy and the appropriateness of the data and resulting reserves. Model Governance should confirm that they are performing as expected and that the appropriate CECL models for each loan pool have been selected.
All figures are for illustrative purposes only. Source: S&P Global Market Intelligence as of October 2017. Content including credit-related and other analyses are statements of opinion as of the date they are expressed and are not statements of fact, investment recommendations or investment advice. S&P Global Market Intelligence and its affiliates assume no obligation to update the content following publication in any form or format.
author Rad Lukic Rad Lukic is a Director and Analytical Lead at S&P Global Market Intelligence, Risk Services. His focus is on assisting financial institutions and other organizations in validating and improving their credit risk assessment methodologies in a Basel II framework. Rad has extensive experience in analytical service development and client engagements, with a focus on developing and validating credit risk internal risk rating systems aligned with regulatory requirements. Rad joined S&P Global in 2006 as an Associate in the New York Risk Solutions Group. He previously held an FX Analyst/Strategist for Emerging Markets position in a foreign exchange brokerage, as well as a consulting position at Mitsui & Co. with responsibility for the Balkan region. Rad received an MBA from the Zicklin School of Business at the City University of New York (Baruch College), and a BSc in Economics from Belgrade University (Serbia).
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the future of CCR for non-centrally cleared OTC derivatives: from a bilateral to a margined world
by Lorenzo Colonna In the aftermath of the financial crisis, the group of Twenty (G20) began to work jointly to promote clearing in the OTC derivative world. For derivatives not suitable for central clearing through the CCPs, the main road taken leads to margining practices. The compulsory use of Initial margin in combination with Variation margin was proposed by the Working Group on Margining Requirements (WGMR). The new VM rules are finally live after the phase-in period since the 1st of March 2017, although regulators across the world, including US, provide forbearance due to the gigantic exercise of CSA amendments and repapering. At the same time, IM is currently entering in the phase-in period and it is supposed to be fully enforced in 2020. The implementation process is strongly supported by ISDA, which has prearranged protocols for the CSA form transition as well as a reference model, named SIMM, to compute IM by using sensitivities. What are deemed to be the potential effects of IM and VM over the non-centrally cleared derivative landscape? The margin regime is designed to protect against counterparty credit risk with a high level of confidence: VM covers the current exposure through the daily exchange of margin. IM goes beyond, by aiming to offer hedging from an upward movement of the exposure up to the 99th percentile and for a 10-day time horizon. However, this will not be a universal panacea. Dark sides may, indeed, potentially come out. First, IM and VM set out a defaulter-pay model by definition. Counterparty risk is not minimized but rather allocated in a different way. To exemplify, CVA held by the survivor party allegedly shrinks whereas MVA paid by the defaulter emerges. This is particularly the case when the defaulter is a SME with high funding costs. Liquidity costs have to be put in perspective also with the LCR requirements. This emerges as a paradigm shift: capital buffers are no longer the first line of defense. Second, margins bear a pro-cyclical drawback: volatile periods will lead to additional margin calls. Market users which need to liquidate assets to post margins may subsequently incur losses due to potential negative market conditions. Hence, posting margins may become particularly expensive and spark a vicious cycle.
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Third, collateral availability should be brought into focus. CCPs already heavily rely on those. The demand of liquid assets may critically increase, also taking into account the strict eligibility criteria and the prohibition to net IM. Without sound and coordinated collateral management practices, a collateral crunch might loom over the markets. MTA appointed in bilateral transactions and cross-margining practices used by CCPs are other tools to avoid a collateral shortage. Fourth, since IM are segregated, market users will supply margins to third-party custodian banks. IM may be concentrated in few custodian entities, by expanding the systemic damages in case of a custodian default. Custodians should ring-fence those assets, since they are often involved in derivative transactions too. Fifth, market users will have to put in place a massive exercise to renew CSA clauses, arrange new margin calls, settle IM within the same business day. Compliance costs for SME may turn out to be burdensome. As a result, they may run cost-benefit analysis to understand whether the cost to be appropriately equipped does not exceed the inconveniencies to close out their OTC operativity. Sixth, although the WGMR sought to foster a level-playing field without imbalances, the application of their principles may not be consistent across the globe. For instance, the scope of coverage between EMIR and the Dodd-Frank Act diverges. Moreover, Brexit cast doubts about the treatment of entities domiciled in UK, which may be excluded by the EMIR regime whether UK will leave the European Economic Area too. Overall, the regulators seem to adhere to a siloed logic, which pursue the maximization of the efficacy but miss to carefully strive for efficiency. The new legal framework produces externalities which may increase systemic risk, jeopardize the competitivity of the system and freeze OTC transactions for certain SME. A significant impact is easily predictable on the OTC market. However, we must wait that the mists of phasein period uncertainty will begin to disappear over the next 2-3 years before fully understand which extent of success and associated issues the regulators will have managed to reach.
author Lorenzo Colonna Mr. Lorenzo Colonna is a risk consultant in Avantage Reply. He has concluded his studies with academic experiences gathered in Italy, UK and Belgium. He has worked on backtesting of derivatives in BNP Paribas Fortis, based in Brussels, and he is currently involved in the AQR exercise for an important Italian bank holding company.
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the risk conversation evolves at the EMEA Risk Leader Summit
by Kraig Conrad & Alexandru Voicu The 2017 EMEA Risk Leader Summit gained momentum with a diverse group of practitioners of over 80 CROs, risk heads and non-executive directors from dynamic startup banks to Tier 1 institutions. The nature of the topics evolved as risk managers managed to overcome the regulatory waves and focus more on strategic and business issues. Risk Leadership membership brings peers together for engaging conversation on specific top-of-house risk topics with follow-on conversation opportunities. Membership is limited and all applications are reviewed by the Risk Leader Committee prior to acceptance and admission. Discussions covered wide-ranging topics such as the Horizon View, Invisible Risks, a Different View of the World and The Future of the Profession. Lifestyle changes and the paradox of physical versus virtual borders applied heavily to this session. The translation of uncertainty to volatility was another. Vendor risk has emerged as important to manage well as we see a rising complexity of the supply chain in Financial Services. The prevailing view was that the battle between David and Goliaths will intensify in the near future with many FinTech startups are driving new forms of intermediation whilst having more agility and benefiting from less regulation. The divergence between rising uncertainty and low volatility is perceived as a warning sign for the times to come, but few expect impending doom. Shifting market dynamics with a heavy impact on technology were discussed as well.
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cyber security and regulation, technology and machine-learning The conversation was heavy on these topics, and many risk experts are educating themselves for the new paradigm we are entering. “Where will the industry benefit?” was a key question with the conclusion that risk managers will not be replaced, but enhanced by machines. It was even a welcome change since risk managers will have more time for reflection and possibly require less time for data mining and reconciliation. Similar concerns were shared at each wave of industrialization and so far humanity has survived with labour markets being very close to full-employment. The conclusion was challenger banks are in a better position to leverage the new platform economy, but at the cost of scarce resources and more prioritization.
culture and conduct, diversity and developing talent, and the risk society – rewired, risk leader – now what? CROs and NEDs defined and discussed culture, how to measure and benchmark risk culture and how it ties into conduct. In financial services, the difference between an honest mistake and a dishonest one can sometimes be difficult to gauge and the panel discussed interesting examples on how to separate fact from fiction. Is risk culture a competitive landscape defined by the competition as well? The general view was that can be a strong differentiator as well. The diversity and talent development panel discussed the pros and cons for buying talent versus growing your own. Examples for retaining talent have been provided such as personal and professional development alternatives when the corporate ladder is obstructed. The accelerating pace of change provides both opportunities and threats at the workplace and there was much debate on how to optimize the relation between the worker and the workplace with technology. There was one shared view of the panel, that of DIVERSITY: of thought, gender, backgrounds, technical skills, etc. Most companies have integrated the second line of defense into the front line and that seems to be the prevailing trend in the next decade. That’s an organizational change that requires some retraining. The integration of IT and Operational Risk have been debated and also the Risk and Compliance functions seemed to be moving closer together. As the CRO position grows in relevance to the business, more and more CROs are starting to move in other business leadership positions. The need to align strategy and risk management was a key highlight of many sessions. The rewiring of the risk society was characterized by the replacement of depth with speed. Truth and its concept may be confused, emotions overwhelm reason which leads to a constant rewiring of society, which in turn change the risk profile of democracy.
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demographics and sustainability, business model optimization and risk strategy, risk management 4.0. The megatrends of climate seemed not to worry insurance underwriters too much from a business perspective. From a personal perspective the impact of these threats is real and malicious. An interesting highlight comes from autonomous driving at various stages, and the impacts on insurance risk-premias. About 40% of general insurance underwriting is auto and about 50% of that business will disappear because of fewer projected accidents, and a more efficient car utilization in the next 10 years. How will that change the operating model provided an interesting discussion. The entire panel was very much aligned about not letting DNA models exclude anyone from the insurance pool, as it would contradict the very nature of insurance companies as risk pooling vehicles. Another interesting examination was of winners and losers in various demographic buckets . This was our flagship EMEA event in a nutshell, but the Risk Leader Series continues in London, New York, and Montreal with topical monthly breakfast meetings accessible to Risk Heads, CROs and NEDs. E-mail adam.lindquist@prmia.org should you like to join the community. We are looking forward to hosting next year’s session, and we look forward to welcoming you.
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authors Kraig Conrad CEO, PRMIA
Alexandru Voicu Technical Advisor, PRMIA
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procyclicality remedies for the CCP’s initial margin requirements
by Elena Goldman & Xiangjin Shen The views expressed in this paper are those of the authors. No responsibility for them should be attributed to the Bank of Canada
CCP risk management framework Central Counterparties (CCPs) base their risk management systems on a tiered default waterfall relying on two types of resources provided by their members: margins and default fund contributions. The initial margins are typically set based on Value at Risk (VaR) calculations. The CCPs, by acting as intermediary, have exposure to both the buyer and the seller.
existing methods of mitigating initial margin procyclicality This article explores the procyclicality of margin requirements based on VaR models. On the one hand, there is a need for margins to adjust to changes in the market and be responsive to risk. Thus, margins are higher in times of stress and lower when volatility is low. However, this practice may produce big changes in margins when markets are stressed which, in turn, may lead to liquidity shocks. In addition, in stable times margins may be too low. CCPs try to reduce the procyclicality of their models by using various methods, including setting floors on margin. Some such methods are discussed in white papers produced by the Bank of England (Murphy et. al (2016). Their study suggests five tools, including a floor margin buffer of 25% or greater to be used in times of stressed conditions. We suggest placing both a floor and a ceiling on margins by using a threshold autoregressive model with three regimes, as well as expert judgement based on historical margin settings. We illustrate the use of this method below.
threshold autoregressive model We estimated the Riskmetrics EWMA volatility model for the SP500 (SPX) and Toronto Stock Exchange (TSX) indices using daily data between 3/17/2003 - 3/31/2017 (3500 observations). The smoothing parameter was very close to .94 in both cases, which is frequently used in practice.
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Figures 1 and 2 show the returns in red and negative values of 1 day 99% Value at Risk (VaR) for SPX and TSX correspondingly. We generated 1 day 99% VaRs using Hull and White (1998) bootstrap method (the blue line) and Normal Distribution (the green line). The margin requirements with Hull and White method are higher because this method uses the actual returns distribution with fat tails compared to Normal distribution. Figure 1.
Figure 2.
Next, we estimated a Threshold Autoregressive Model with three regimes and two corresponding thresholds. The results for thresholds are given in Table 1 and presented graphically as horizontal black lines in Figures 1 and 2. Table 1.
The three-regime threshold model provides a straightforward method of setting both the floor and the ceiling for the initial margin that is stable and not too procyclical: the margins are bounded between 1.82% and 2.90% for SPX and between 0.79% and 1.02% for TSX. This way when volatility is low the margins are fixed at a conservative floor level that corresponds historically to about 25% quantile of lowest margins for SPX and at the time of market stress they can’t go above the upper threshold. It is an interesting coincidence that the estimated lower threshold for SPX corresponds to the 25% of observations as was also suggested by Murphy et. al (2016). For TSX the margin buffer is a higher 34% of observations. On the other hand, at the time of stress the higher regime thresholds correspond to 31% and 40% of the observation points for SPX and TSX correspondingly, which does not appear too conservative. One could add here actual historical margins set by CCPs at the time of stress, to see if the upper bound was historically higher and would have resulted in a lower percentage of observations for the high regime. In order to guarantee that the margin floors and ceilings would be sufficient at the time of crisis, we need to make sure that the time series of VaRs in the regime of high volatility are stationary and revert back inside the bounds. If the margins were allowed to be set within two bounds and the high volatility regime was not persistent, margins would be stable. Such policy could be also useful to manage expectations at times of stressed liquidity.
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conclusion The mandatory use of CCPs in certain markets is one of the cornerstone regulations introduced to prevent another global financial crisis. However, the rules implemented have not been tested in crisis conditions. The dialog, therefore, remains open for constructive proposals to fine-tune these rules, such as presented in this article.
author Elena Goldman Elena Goldman is an Associate Professor of Finance at the Lubin School of Business at Pace University. Her research and teaching are in the fields of Financial Econometrics, Bayesian Econometrics, Risk Management, and International Finance. Her current papers are on systemic risk, asymmetric volatility, and margin models for Central Clearing Counterparties. She currently serves on the Education Committee at PRMIA. Goldman was a fellow at the SEC in 2016. She holds a Ph.D. in Economics from Rutgers University.
Xiangjin Shen Xiangjin Shen is a Senior Economist in the Financial Stability Department at the Bank of Canada. Her policy work focuses on the financial stability and macro-economic stress testing issues. Her current research interests include econometrics, monetary transmission mechanism, bank funding transfer pricing, stability of clearing agencies and tail risk. Before joining the Bank of Canada, Xiangjin worked as a Senior Manager in the Global Risk Management department at the Bank of Nova Scotia. Xiangjin received her MS in Statistics from the University of New Mexico and PHD in Economics from the Rutgers University.
i / D. Murphy, M. Vasios, N. Vause, An investigation into the procyclicality of risk-based initial margin models, Bank of England Financial Stability Paper No. 28 (2014)
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PRMIA risk leader initiative Chief Risk Officers ready to help steer blockchain technology Where might you find a room full of Chief Risk Officers (CROs) engaged in a robust discussion about blockchain and smart contract technology? The answer is at the PRMIA Blockchain Roundtable for CROs. Bright and early in a conference space generously hosted by GQR Global Markets, PRMIA CEO Kraig Conrad welcomed a room of CROs in attendance to discuss opportunities and risks associated with emergence of blockchain and smart contract technology within financial services. The discussion, moderated by Andrew Pedvis, head of product development at Fitch Ratings, steadily gathered momentum with no sign of abating at ten minutes past the scheduled conclusion. The CROs represented a diverse group of financial services firms with a majority being asset managers. Beginning with an overview of how this ‘shared ledger’ technology could help to record and transfer the ownership of just about any type of asset in digital form the room then erupted into viewpoints of whether certain industries had already achieved similar goals with advanced shared databases or whether blockchain really added the level of ‘trust’ that other approaches have lacked in the past. Soon others in the room were invoking examples of blockchain technology being tested in areas as diverse as real estate, trade finance, collaborative document management, cybersecurity, identity management, private equity issuance, and the like. About a third of the firms had active working groups focused on either blockchain or emerging technology. The group had an appreciation for the benefits of increased efficiency that can come with a shared infrastructure as well as the increased resilience that could be gained from the ‘distributed’ nature of this ledger technology. However, there was also a common concern within the group that the technology could increase ‘tail risk’ – a low probability but high impact risk of failure - not to one firm but across the shared system. Marc Groz, head of the Stamford, Connecticut chapter of PRMIA who was in attendance captured a shared sentiment when he said that, “Risk never goes away but only changes its form”. Although optimism abounded for a technology that could reduce risk and costs by automating processes, there was certainly no consensus in the room as to when blockchain technology would become prevalent. One CRO suggested that it would likely take 5 years for the technology to take hold, while another quickly interjected that it could not possibly take that long and yet another jumped in that 5 years was far too soon. Another prominent theme was that risk leaders felt it was important not to obsess over any one technology and that there were plenty of other innovations that could be used to target ‘low hanging fruit’ in the world of risk such as with data science and artificial intelligence. Risk leaders are optimistic that there is risk reduction and efficiencies to be gained by the technology and they are mindful that shifting processes will require adaptive controls. If one thing is certain it is that this group will not be satisfied to sit on the sidelines of this evolving market. Intelligent Risk - December 2017
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the unintended consequences of cybersecurity regulations
with Bogdan Botezatu We sat down with Bogdan Botezatu, senior e-threat analyst at BitDefender, to discuss cyber-threats and regulation in the financial space. And while we expect threats to be uneven, it looks like the regulatory environment is the same.
Q
We’ve seen enormous benefits of digitization. What are the latest cyber threats facing the financial industry? (Banker Trojan related) Bogdan Computer fraud remains the biggest threat to the financial industry. It affects both the bank’s infrastructure and the bank’s customer as well. While targeted attacks against banks are still rare and usually make headlines worldwide (such as the Lazarus group – a supposedly North Korean hacking group involved in the 2016 Bangladesh Bank heist), thousands of users silently fall victim to financial malware known as Banker Trojans.
Q
Where do you see the largest vulnerabilities in the system? (general level)
Bogdan Most of the time attackers target the weakest link in the system and this is almost always the bank’s customer. Rather than developing extremely sophisticated malware that could be able to fly under the bank’s internal security mechanisms, hackers develop customized malware for the bank’s customers. The end result is still financial fraud, but at a smaller, less prominent scale.
Q
You’re saying this manipulates the webpage, on a bank property. Is it the bank’s responsibility or the user’s responsibility? How does regulation treat this item? Bogdan Banker Trojans manipulate transactions and webpages on the client’s side, practically positioning themselves between the client and the bank, but outside the bank’s infrastructure. Since the Trojan technically runs on the victim’s computer, the bank considers this as the user’s responsibility. Some banks provide security software for the users’ computers for free as part of the e-banking service subscription, just to minimize the threat. Since this does not technically affects the bank, Banker Trojans fall into the grey area of regulation. Institutions such as the US DHS have issued the Financial Services Sector-Specific Plan, a 2015 document that outlines the prerequisites for operating interconnected critical infrastructure.
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The G7 has issued a similar document, but just like the DHS release, it is non-binding and does not explicitly address the issue of banker Trojans. The documents call for cooperation and enrollment of financial institutions in a collaborative threat intelligence sharing platform that would help spot and document malware outbreaks such as banker Trojans.
Q
Please give us an overview of PSD II and what are some industry repercussions you see.
Bogdan PSD II is a regulation that helps merchants and FinTech companies the world over to query the available balance of a potential customer via requests to the bank’s open API. This regulation stipulates that this way merchants will have extra mechanisms to suggest products or to offer crediting based on the customer’s real buying power. By the way it is phrased today, PSD II seems to contradict the GDPR, whose role is to minimize the publicly available information about the user, their financial status and balance, not make it easier to access outside of the Bank’s circle of trust. Secondly, having personal financial information on display on any kind of website in a widget will likely numb the users’ senses and make them less reactive to cyber-fraud such as phishing attempts.
Q
What are the architectural changes stemming from PSD II?
Bogdan In order to implement PSD II, banks will have to rethink and rewrite their web services to expose APIs. It is unclear how access to these APIs will be granted or how authentication will happen, but the more parties have access to the data, the higher the chances of a data leak.
Q
How does that affect the user experience and how do you expect trust to evolve?
Bogdan Bank customers will become increasingly more confident in the financial service’s capabilities to defend against fraud and cyber-attack, but this is the only area of the PSD II directive that is not detailed upon. There is no limit of liability and no real-life scenario for implementing the framework, securing it and then making it compliant with potentially conflicting directives and regulations such as GDPR.
Q
Does this contradict some of the GDPR regulations?
Bogdan Yes, it does. While the PSD2 is all about making the data of individuals available to third parties, the GDPR is all about keeping this data private. And while PSD II’s main purpose is to interconnect banks with third parties, GDPR clearly states that the individual has to give explicit consent and to provide the data to the data processor – the bank can’t act as a proxy for information sharing with third parties.
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Q
How can we harmonize the 2 systems?
Bogdan GDPR - not only that it will enter into effect in May next year, it was officially ratified in April 2016. While the common factor between PSD II and GDPR is consent from the user, this might not be sufficient to make GDPR work with PSD II. And if the provisions of the PSD II turn to be impossible to harmonize with GDPR, the former will end up eclipsed by the enormous stakes of GDPR (up to â‚Ź20M or 4% of global turnover if breached). In this case, most banks will forget PSD II and focus entirely on GDPR.
interviewee Bogdan Botezatu, Senior E-threat Analyst at Bitdefender Bogdan Botezatu has spent the past 10 years as a Senior E-threat Analyst at Bitdefender. His areas of expertise include malware deobfuscation, detection, removal and prevention. Bogdan is the author of A History of Malware and Botnets 101.
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on regulating crypto currencies, tokenised assets, and ICOs
by Stefan Loesch Crypto currencies -and more generally crypto assets- have been doing rather well lately, which has raised strong interest from investors who have started questioning whether this is an asset class to which they should start paying closer attention. In this article, I want to give a brief overview over this interesting new sector, and in particular also touch upon how it fits in with the world of traditional finance and its regulations. Let me start with a brief overview of what crypto assets are. There are a number of definitions out there, but the ones I prefer to emphasize are: 1. Electronic entries in a distributed and censorship-resistant ledger, and that 2. Ownership and control is asserted via knowledge of a cryptographic secret key Within this universe, firstly there are crypto-currencies like Bitcoin, Ethereum and ZCash which are considered the crypto equivalent of currencies—they can be transferred to other people in order to make payments or they can be hoarded to store value over time. Importantly, their value is not tied to anything specific, so they trade at whatever value supply and demand dictate. Secondly, there are financial asset tokens where a token represents a well-defined asset. An interesting application that people are working on is a fractional ownership model for real estate, or for more esoteric assets like paintings. To give an example, there could be 10,000 tokens issued against a specific house, and the token holders would have certain ownership rights. For example, they would receive the income from the property, or the proceeds if it is ultimately sold, so ultimately it is a financial investment, akin to an ultra-targeted real-estate fund. There are also product tokens, where a token entitles the holder to receive a certain product or service in the future. This is interesting for start-up companies that are still developing their offering and can use tokens to pre-sell it to their customers. This would thereby raise financing that they would have otherwise needed to raise from a bank or a venture capital firm. Finally, there are network tokens, which is the instrument that underlies most ICOs. It could be described as a single-purpose currency as it is designed to be used as means of payment on a specific platform. The platform in question typically connects providers and consumers of products or services, but that does not itself produce anything. An example would be a ride-hailing platform matching people who want to provide taxi services and those who are looking for a ride and where all transactions must be settled in network tokens rather than in cash.
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Whilst regulators are still trying to understand those different uses, a picture starts emerging slowly: regulators are trying to map these crypto assets into well-known categories in traditional finance. Regulators differ in their eagerness to attract new financial services, so there are locations where it is easier to get regulatory traction than in others. The globally distributed nature of the crypto networks makes the notion of location hard to define: the assets are registered in synchronized ledgers that co-exist in many countries at the same time, and the asset owners can transfer their assets freely amongst network addresses, and there is currently no good way of asserting in which country the owner of a given network resides. In absence of globally agreed practices, the location uncertainty translates into an uncertainty which regulators might eventually have to address for the potential risk of things going wrong and retail customers under their jurisdiction suffering losses. The middle-of-the-road view currently seems to be that crypto currencies are either considered currencies or commodities, the main difference being tax treatment. They are bearer assets like cash, so people using significant amounts of crypto assets either exchange them into regular currencies, or to pay for products, services or assets will generally be subject to AML and more generally KYC procedures. As for asset tokens, regulators tend to have a rather positive view on them as they are seen as an innovative way for small companies to raise financing. For example, non-tokenised crowd-funding requirements have been getting tighter, mostly to ensure that companies do not treat the money raised as free money; instead they are actually delivering on their promises. The situation for financial asset tokens is more complex. It is very difficult to not consider them derivatives or securities, which is one of the reasons why development in this area has been slower. Also, compliance with the applicable laws and regulations is often hard to do within the constraints of the crypto asset world. Last but not least, network token regulators have been standing on the side lines and have been observing what is happening in the ICO world where substantial amounts of funding have been raised recently. The jury is still out where this space will end up, if only because it is far from clear what people who invest in ICOs are actually buying and what the underlying economics of ICO tokens are. So overall an exciting space to watch—it is unlikely that the crypto world will replace the world of traditional financial services just yet, but it is an exciting technological change that in the medium to long term could profoundly impact the way financial services are delivered, both in the retail and in the wholesale space.
author Stefan Loesch Fintech Executive and author of the book “A guide to Financial Regulations for Fintech Entrepreneurs� (Forthcoming Wiley)
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the evolving regulatory framework on cryptocurrency: what lies ahead?
by Vivek Seth Over the past few years, cryptocurrencies have gained not only the mainstream media attention but also have piqued retail & institutional investors’ interest as the new frontier for seeking capital gains. Cryptocurrency, also at times referred to as “virtual currency” or “digital money” is essentially a peerto-peer electronic cash system based on blockchain concept that facilitates direct online payments from one party to another without going through a traditional financial institution acting as a third party. Statistics speak for themselves on this phenomenal growth of the virtual currency market: there are currently more than 1000 cryptocurrencies being traded1. The value in US Dollar of two popular cryptocurrencies Bitcoin and Ethereum, have risen year to date by close to 500%2 and 3400%3 respectively (as of late Oct 2017). Key arguments cited on this rise of cryptocurrency platforms include lower processing payment fees compared to that charged by financial institutions and encryption driven chain of digital signatures being less prone to conventional fraud attempts including identity theft. Digital money’s rising popularity is also attributed to its easy accessibility including to those who may not meet the traditional financial systems’ customer criteria. Cryptocurrencies are increasingly being seen as a new source of wealth creation worldwide and as the latest method of doing commerce. Skeptics of cryptocurrencies however, point out that due to its decentralized and encrypted nature, this digital money system is prone to money laundering & other illicit transactions. Implementing standardized KYC policies & robust controls is a challenge given it is harder to track the individuals behind virtual currency when compared to traditional financial payments. Another concern is that the digital money may be vulnerable to cyber attacks as seen in the case of Tokyo based Bitcoin exchange Mt.Gox which once handled 80 percent of the world’s Bitcoin trades but filed for bankruptcy in 2014 after losing to hackers Bitcoins worth around half a billion USD and 28 million USD in cash from its bank accounts.4 Cryptocurrencies may also give rise to electronic versions of traditional frauds as seen from the recent case of US authorities charging a UK dealer with securities fraud & deceiving investors via multimillion-dollar fake Bitcoin site scam.5
1 / Source:https://coinmarketcap.com - Link 2 / Source: Currency chart generatedfrom http://www.xe.com - Link 3 / Source: Currency chart generated from https://www.coingecko.com - Link 4 / Source: www.reuters.com, “Chief of bitcoin exchange Mt. Gox denies embezzlement as trial opens”, 11 Jul 2017 - Link 5 / Source: https://www.theguardian.com, “UK dealer charged in US over multimillion-dollar fake Bitcoin site scam“, 1 July 2017 - Link
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We are currently in the evolving stage with varying degrees of regulations seen across the world. For example, Switzerland has forged a growing reputation as a global cryptocurrency center, with Swiss foundations accounting for a quarter of the wealth raised by cryptocurrency crowdfunding ventures in 2017.6 Another country with this welcoming outlook is Sweden where the central banks are currently considering introducing a digital form of government-backed money based on cryptocurrency technology.7 There are also quite a number of nations with less favorable regulatory stance (e.g. China) who have banned the practice of capital raising through the sale of cryptocurrency.8 In the past, nations who were open towards technological advancements such as introduction of internet, globalized outsourcing etc. were able to adapt with changing times. Likewise, countries that will sustain a favorable regulatory view on cryptocurrency would be placed in a better position to make the best out of changing business landscapes. To stay internationally competitive, eventually the democratic part of the world is expected to have a favorable regulatory approach towards cryptocurrencies with regulated oversight on following aspects: 1. Requirement of registration with approval authorities for engaging in digital currency business: Apart from the registration fee, businesses engaging in cryptocurrency would be required to have standard financial internal controls such as transaction record keeping requirement, checks against false/misleading marketing, registration for operating online trading platforms amongst other rules. Individuals and businesses found violating the requirements would be reprimanded on lines of the US SEC sanctioning in Dec 2014 a computer programmer for operating two online venues that traded securities using virtual currencies without registering the venues as brokerdealers or stock exchanges.9 2. Requirement of AML Controls: Business offering cryptocurrency platforms in the future would be expected to mitigate money laundering risks via requirements of proof of identities at account opening, periodic review of accounts, obtaining information on customer tax assessment, information requirement on payment to third parties as well as threshold on exchanging virtual currencies against USD or other official currencies. Businesses would be required to cooperate with regulators on providing information on suspicious transactions and refusing to do business with customers insisting on complete anonymity. Such an oversight approach would definitely require initial adoption time for business, but if properly enforced would obviate away the money laundering risks associated with virtual currencies.
6 / See www.openbankproject.com - Link 7 / Kristin R. Moyer, “Hype Cycle for Open Banking APIs, Apps and App Stores,” Gartner, July 6, 2015. - Link 8 / James Haycock and Shane Richmond, Bye Bye Banks? (Wunderkammer, 2015). - Link 9 / Chris Skinner, Digital Bank (Marshall Cavendish International, 2014). - Link 10 / Source : https://www.sec.gov/oiea/investor-alerts-bulletins, “Investor Alert: Bitcoin and other virtual currency-related investments”, 7 May 2014 - Link
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3. Emergence of Regulatory Guidelines, Notices and Investor alerts on Cryptocurrencies: These formalized regulatory communications would help consumers to be timely aware of the evolving nature and risks associated with digital currencies such as risks of financial loss due to fraud, price volatility, cyber security concerns among others. One example of such an alert was the US SEC Investor Alert in 2014 that aimed to make investors aware of the potential risk of virtual currencies.10
conclusion Cryptocurrency technology in the commercial arena is here to stay and should not be ignored as a passing phenomenon. Whether it will stay as an alternative or surpass the traditional commerce, one thing is certain: cryptocurrency technology has the potential to become an integral part of the global economy that could disrupt traditional industries and transactional systems. Countries with proactive regulations would adapt via developing a favorable attitude towards cryptocurrency technology and evolving regulatory landscape to ensure that the benefits of this technology is harnessed while limiting its side-effects.
author Vivek Seth Vivek Seth has been working in the Risk Management area for over 13 years. Currently working in the Financial sector in Singapore, his work experience extends across Singapore, Australia and India, along with business assignments carried out in Hong Kong and Switzerland. He holds an M.B.A. and also the PRM™ professional certification. This article presented here represents author’s personal views and not those of his current/previous employers or that of any professional bodies he is associated with.
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regulations upgrade in China’s equity market “If Winter Comes, Can Spring be Far Behind?”
by Qi Lu & XinXin Li aftermath of a crisis China’s stock market experienced a meltdown in 2015. In 14 trading days, approximately 30% of its market value evaporated. When investors rushed to safety, the government stepped in as buyer of last resort. It was unofficially estimated that 1.0-1.5 trillion RMB was employed to stabilize the market and restore market confidence. Since then, the philosophy of regulation has changed from “facilitate innovation and foster a bullish market to cooperate with economic reform” to “keep the market stable and prevent systematic financial risk.” The China Securities Regulatory Commission (CSRC) has published a series of stock market regulations since 2016 which refer to stock new issuance, financing and refinancing, stockholding reductions and control of leverage. These measures have successfully stabilized the market, however, at the cost of lowering liquidity as measured by trading volume. The traditional business assumptions of a highly liquid stock market, such as stock collateral financing, private placement refinancing and block trading for shareholding reductions, have all been affected. Moreover, an adjustment to valuation logic is taking place. In other words, market preferences are changing.
bringing discipline to IPOs The flow of public stock offerings is now accelerating. There are several considerations involved in this trend, including steering IPOs finally toward market-oriented issuance requirements by introducing a Registration IPO which is an issuance form with focus on information disclosure instead of administrative approval, to facilitate financing of the real economy and to alleviate accumulation of names in the CSRC’s IPO-examination list. While this IPO acceleration has increased the supply of stocks, it will not produce market discipline until the IPO myth has broken, where in China most investors believe that IPO stock is risk-free and a high-profit opportunity. Moreover, in the past IPO prices were artificially depressed by official guidelines on IPO pricing mechanisms, which further boosted the IPO stock boom, reinforcing this belief.
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restricting stock financing Stock collateral financing and private placement refinancing are the two most important financing methods in China’s equity market. The former benefits both from the stock price +/-10% daily limit rule and from the current status that to delist a stock from the public market is difficult in China. Thus, as a collateral asset, listed stocks got favorable weight in various types of financing. The latter prevailed because of the huge margin between the primary and secondary markets. Specifically, when private placements were launched in the quasi-primary market, investors not only had access to huge positions but also enjoyed a big discount to the eventual market price during the lock-up period before they become salable in the secondary market. These attributes result in private placements being a highly desirable refinancing tool and in M&A an important source of profit. Stock financing is subject to more restrictions now. The two financing ways mentioned above were frequently abused in the past, especially private placements, which promoted conflicts of interest and stock market hype by encouraging market preference to overweight on small-cap, poor-performance and hottheme shares. This is considered to be one of the factors which caused the market meltdown in 2015. The CSRC published new rules to regulate private placement refinancing in February 2017 and stock collateral financing in September 2017. In private placements, the core of the new regulation is to cancel the discount spread between the quasi-primary and secondary markets. It also established norms for stock issuance amounts, time interval for refinancing applications, and use of financing funds. In collateral financing, the regulator put new requirements in place which mainly focused on concentrations that an institution can accept stock as collateral, and also the percentage of a listed company’s shares that can be used as collateral. The impact of this regulation is shown in the chart below.
Stock Financing via Collateral and Private Placement
Source: Wind financial terminal & database
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shareholding reductions Large-scale reductions in shareholdings via the secondary market have become harder for specific shareholders. To stabilize market expectations, the CSRC introduced regulation of shareholding reductions in May 2017. This regulation is an intensified version of the temporary measures adopted by the CSRC during the period of stock market turmoil to limit selling by large shareholders rushing to safety, which created significant pressure on market stability at the time. The new rules mainly regulate the conduct of reducing shares in the market by large shareholders who have the advantage in shareholding amount, such as insiders who are privy to business information and private placement investors who enjoyed a good issue price discount. These regulations resulted in leverage employed to access the stock market being strongly curtailed. The CSRC set a cap on the leverage which tranche-structured funds, whether private or public, can employ to invest the stock market. The tranche funds, in the way that equity tranche investors with the aid of senior tranche capital, generally from a bank, were deemed the most destructive influence in 2015’s market turbulence. In fact, not only the CSRC acted, but the China Banking Regulatory Commission (CBRC) also applied a similar regulation to banks and banking-like institutions.
conclusion This comprehensive regulatory upgrade has, in the short term, had a negative impact on market vitality; however it should contribute to market fairness and stability in the long run. In short, if Regulation-Winter comes, can Market-Spring be far behind?
authors Qi Lu, PRM, CAIA Qi Lu is the independent approver & Asst. GM of risk at Zijin Trust, a joint venture of Sumitomo Trust Bank in China. In his capacity, Qi is responsible to consult, guide and approve the capital market investment and cover its risk management. Prior to joining Zijin Trust, Qi served for HwaBao Trust, a capital market leading trust company in China, as Risk Director of Capital Market and member of Security Specialized Commission under The Decision making-committee. Qi held the position of Risk Manager in Morgan Stanley Huaxin Fund, a joint venture of mutual fund in China and Quants in ING Investment Management, the pension fund ‘Afore’ in Mexico.
XinXin Li Xinxin Li is currently interning in Zijin Trust, under the supervision of Qi Lu. She is an undergraduate majoring in Business Management and minoring in Finance at Shanghai University of Finance and Economics. She studied in Queen Mary University of London (QUML) as a visiting student for a term in 2016. Her research interests include risk management and industrial organisation.
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energy banking regulations: the good, the bad, and the ugly
by Ajay Prakash Regulations are needed for markets to functions in a transparent and fair manner, ensuring long-term feasibility and stability. Ideally, financial regulations should be structured and pre-emptively implemented to serve the purpose in any future business scenario. In reality, we often see financial regulations being poorly structured and hastily implemented as they are often a reaction to a black-swan like extreme market event, which is highly unlikely to be repeated again. The recent case of new Energy Banking regulation shows that even a much-needed and meticulously drafted financial regulation can create disruption and uncertainty for businesses just due to bad timing. Oil and gas production companies predominantly relied on debt capital to fund growth until 2016, when Office of the Comptroller of the Currency (OCC), US Department of Treasury issued new lending guidelines for the banks. As a result, banks had to cut their credit lines to the energy companies that were already struggling with liquidity in the wake of low commodity prices. While the regulatory tightening was probably needed, had it been issued earlier, it could have saved banks and the energy industry from a lot of distress. Since early 2000s, the US shale oil and gas production growth has been a phenomenal success story. It’s a marvel of American innovation and enterprising spirit. Oil and gas is a capital intensive business and all this growth capital was provided through large amounts of debt capital alongside equity capital from private equity firms. While geologists and engineers were pushing the envelope on the technology front, private equity firms and banks were using financial engineering to provide all the capital to fuel that growth. It all worked fine until 2014 when oil prices started tumbling and dropped almost 60% by 2016. As oil prices dropped from the highs of $85/bbl in June 2014 to less than $30/bbl by early 2016, oil and gas companies with high levels of debt realized their capital structure was not sustainable under the new commodity price environment. As oil and gas producers started cutting costs and growth capital budgets, oil field services companies started feeling the pain too. At the same time, in 2016, OCC issued more stringent energy lending guidelines, forcing banks to cut their credit lines for energy companies. The regulatory guidelines tightened at a time when the industry was going through its most difficult time in decades. It sealed the fate for a large number of energy Companies that were already struggling with liquidity. As a result, during 2015 and 2016, over 90 companies filed for chapter 11 bankruptcy protection and restructured over $70 Billion in debt.
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ver the years, private equity firms were capitalizing new oil and gas companies with as high as 75% debt in order to leverage their equity returns. At the same time, banks were providing senior secured credit facilities to these energy companies with large amounts of junior debt, taking comfort in their first lien security over the collateral formed by oil and gas assets. As their leveraged finance teams were busy making juicy returns on junior debt issuances, banks didn’t pay attention to the fundamental difference between Probability of Default (PD) and Loss Given Default (LGD). While a first lien security helps with recovery (lower LGD), unsustainable debt levels could lead to default in a low commodity price environment (higher PD). Thus, it was high time for more stringent energy lending guidelines to bring banks on the right track. The new OCC lending guidelines rightfully targeted the prevalent faulty and aggressive lending practices in the US Energy Lending space. The only thing ugly in this regulatory action was the timing. For a debt bubble that was grown over a decade, regulators took an action when the deep rooted trouble started surfacing in a difficult industry environment. As a result, a sensible and required regulation ended up being disruptive for the industry. While most of us will agree with the need for this new regulation, it’s important to acknowledge that this regulation could impact the availability of capital to energy companies in the long-term. While this is currently not an issue as the US oil and gas production is high, in future it might pose an issue for the industry and could also touch upon the issue of national energy independence. As in the past, future financial regulations are also likely to be implemented in reaction to some adverse market events. Therefore, in this fast changing and uncertain regulatory environment it’s imperative for financial institutions and businesses to remember the fundamentals of risk and not get swayed by shortterm profits, even if the required regulations are not put in place yet.
references 1. “Oil and Gas Exploration and Production Lending” 2. “U.S. banking regulator to focus on energy, interest rate risks”
author Ajay Prakash Ajay Prakash is a Vice President at Nataxis. Mr. Prakash has been working in Energy Credit and Banking space since 2009. Prior to joining Natixis in 2015, Mr. Prakash worked with several international banks such as Crédit Agricole CIB, Macquarie, and Societe Generale. Mr. Prakash has an MBA from Jones Graduate School of Business, Rice University and a bachelor’s in Mechanical Engineering from Delhi Technical University, New Delhi.
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has regulation changed risk management?
by Grigoris Karakoulas The increase in regulation of financial services, particularly in the aftermath of the Great Recession, has changed how risk is measured and managed in financial institutions around the world. In this paper we discuss how the changes have materialized and point out opportunities for improvement for regulations as well as for risk management. As a result of the increase, two types of risk have been brought to the forefront of risk management: compliance risk and regulatory risk. Capital regulations have also introduced new measures for different types of risk (market, credit, operational, interest rate and liquidity). In 2009, as the uncertainty about asset quality became elevated after Lehman’s collapse, the US Federal Reserve successfully demarcated and mitigated this uncertainty using stress testing under the Supervisory Capital Assessment Program (SCAP). Since then stress testing has appeared in many regulatory guidelines with the inadvertent consequence of being viewed by financial institutions as primarily a regulatory compliance issue. Opposition for regulation has lately been mounting, particularly in the US. One aspect of the latter opposition has to do with a limitation in that many regulations use the amount of bank assets to identify and classify firms whose failure could pose risk on the financial stability. However, size alone does not equate to risk to financial stability. For example, the Dodd-Frank Act specifies asset thresholds of $10 billion, $50 billion and $250 billion which categorize institutions in a manner that may be unrelated to actual risk. According to OFR’s analysis of systemic importance1 some large banks may not be systemically important whereas some smaller banks might be. The Basel committee has been revising its G-SIB identification methodology using a multi-factor approach and accounting for dependence on short-term funding2. Recent statements from Federal Reserve Governors indicate relaxing the above asset thresholds and hence the associated enhanced prudential standards. Perhaps a modified version of the G-SIB multifactor methodology for the second tier banks in the US might be a better approach than just relaxing the asset thresholds. Another aspect of the opposition has to do with the scenarios involved in stress testing. According to regulatory agencies worldwide, scenarios should be severe yet plausible. Lack of a quantifiable scenario plausibility has been a commonly quoted reason for unsuccessful integration of stress testing as a decision-making tool in an organization, rendering it a mere regulatory compliance issue. Scenarios should also be coherent. Scenarios are inherently multi-factor and should contain variables at different granularity levels of the real economy, financial markets and geography to reflect the jurisdiction and portfolios of the institutions. 1 / Office of Financial Research. Size Alone is Not Sufficient to Identify Systemically Important Banks. October 2016. 2 / Basel Committee on Banking Supervision. Consultative Document: Global systemically important banks – revised assessment framework. March 2017.
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Defining coherent scenarios across multiple variables is important for setting CECL/IFRS9 loss provisions and capital levels. An inconsistent scenario may lower the provision and/or capital charge for some activities relative to others. If banks can anticipate which variables are inconsistently stressed, then this creates the potential for regulatory arbitrage. Regulatory scenarios (DFAST/CCAR3, EBA4) have typically been provided with a qualitative assessment of their plausibility, e.g. adverse or severely adverse. It is not clear whether the macroeconomic variables specified in the stress scenarios are consistent with each other. For example, are the shocks in macroeconomic variables such as GDP and unemployment, consistent with the stresses in financial variables such as return on market index and volatility index? Similar qualitative assessment has also been associated with company-run scenarios for capital estimation. On the other hand, the scenarios for CECL/IFRS95,6 loss provisioning will have to be generated at pre-specified likelihoods (plausibility) so that these probabilities can be used as weights for estimating the expected credit loss. The new IRRBB standards7 require banks to also use scenarios for measuring and managing interest rate risk. Thus, institutions need to have a scenario generation capability which can produce coherent multi-factor scenarios at different probability levels in order to ensure consistency between capital adequacy assessment and loss provisioning activities. Related to the aforementioned limitation in asset size thresholds and part of the argument for their relaxation is relevance of the scenarios. Midsize banks in the US are subject to scenarios with national macroeconomic variables that may not be relevant to the risks of their geography or assets. Selecting the level of granularity in scenarios is of paramount importance. For example, a macroeconomic shock at the national or regional level could impact house prices significantly differently across neighborhoods of an MSA. Ignoring such heterogeneity and using scenarios at the national or MSA levels may lead to potential underestimation of losses depending on the concentration of a bank’s residential mortgage portfolio. Scenarios at the neighborhood level can capture this heterogeneity, uncover vulnerabilities, and allow a bank to mitigate the risk. Despite their limitations, new capital regulations and accounting standards (CECL/IFRS9) have made imperative the integration of Risk with Finance for strategic planning and execution, thus elevating the role of the Risk group in enterprises. Stress testing with plausible, coherent and relevant scenarios has a unique potential for integrated, enterprise-wide decision-making and promoting financial stability.
Grigoris Karakoulas, is the president and founder of InfoAgora Inc. that has provided risk management consulting, prescriptive analytics and RegTech solutions (IFRS9/CECL/IRRBB/ Basel III) to Fortune-500 financial institutions with multi-million dollar benefits. He is also Adjunct Professor in the Department of Computer Science at the University of Toronto. Grigoris has published more than 40 papers in journals and conference proceedings in the areas of machine learning, risk management and predictive modelling in banking. 3 / They are the successors of SCAP in US
4 / EU-wide stress test run by the European Banking Authority.
5 / International Accounting Standards Board. IFRS 9 Financial Instruments. July 2014. 6 / Financial Accounting Standards Board. Financial Instruments – Credit Losses (Topic 326). FASB Accounting Standards Update. June 2016. 7 / Basel Committee on Banking Supervision. Interest rate risk in the banking book. April 2016.
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to FRTB and beyond
by Sanjay Sharma In January 2016, BCBS released revised minimum capital requirements for market risk following their eight-year long Fundamental Review of the Trading Book (FRTB). This framework represents an overarching view of how risks from banks’ trading activities and portfolios should be assessed and quantified through a credible and intuitive relationship with capital requirements. Principal components of the new guidelines include: a clear and impermeable boundary between banking and trading books, replacement of VaR by expected shortfall as a risk measure, revised sensitivity-based standardized approach, and revised expected shortfall-based internal model approach with differentiated liquidity horizons. The principal objectives of BCBS for FRTB are to achieve consistency across jurisdictions, for its standardized approach to serve as a credible fallback and a floor to the internal models approach, and to address existing weaknesses in the current internal models approach – with the overarching motivation to not significantly increase bank capital requirements. Adoption of FRTB standards will require substantial overhaul of banks’ risk analytics frameworks and processes including model selection, validation, and computation of parameters. FRTB will also have far-ranging implications on how trading books will be organized, capitalized, managed, and regulated. FRTB is required to be implemented by year-end 2018. FRTB draws heavily on lessons learned from unobserved risk build-up leading up to the 2008 financial crisis and addresses the following inadequacies and inconsistencies of Basel 2.5 and other related standards. Initial estimates suggest that the increase in capital charge for banks’ trading books from FRTB adoption will be in the range of 40% higher than current Basel 2.5 capital requirements for trading desks/banks. Further, banks adopting the standardized approach are expected to experience capital charges 40% higher than for desks/banks adopting IMA. The sheer increase in capital charge has attracted the attention of bank senior managements. Further, the wide gap between the standardized and internal models approaches will set the stage for competitive rebalancing across the industry. FRTB rules and guidelines allow for banks to use internal models approach at a desk level (as opposed to at business or institution level in existing rules). This flexibility in selecting between the two approaches allows management to be selective in investing in risk and analytics frameworks and allocating capital. Furthermore, this selectivity will allow capital markets management to have flexibility in organizing trading desk structures towards optimizing capital deployment. FRTB will reward availability and consistency of market data as well as integrated and robust analytics frameworks. A case in point is that regulatory approval for adoption of the internal model approach will require banks to demonstrate operational capability to be able to run the analytic frameworks on a regular basis.
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Regulators should be concerned about under-computation of capital charge and vice versa for traders, desk and business heads, and senior bank managements. Regulators may well question over capitalization of trading desks, but anecdotal evidence of a regulatory scrutiny of overcapitalized desks or banks is rare unless it suggests excessive risk taking. A logical response to this phenomenon is for both regulators and managements to ask for benchmarking of models and computation methodologies and “challenger� environments.
what are the key elements of FRTB? 1. Revised, stricter boundary between the trading book and banking book This creates a less permeable and more objective definition that is aligned with banks’ risk management practices, and reduces the incentives for regulatory arbitrage. FRTB provides explicit definitions of trading instruments and Regulatory Trading Desks (RTD) and prescribes an extensive list of instruments presumed to be in the trading book with requirements for explicit approval from its supervisor for any deviation from this list. 2. Restriction on movement between books FRTB sets strict limits on the movement of instruments between banking book and trading book. In the rare instance that a transfer is allowed, disclosed Pillar 1 capital charges will be recorded. 3. Enhanced supervisory powers and reporting requirements Supervisors will now have discretion to initiate a switch in instruments between books if deemed improperly designated. Banks will also be required to provide enhanced reporting, evaluation and monitoring of boundary determination and compliance including inventory aging, daily limits, intraday limits and assessments of market liquidity. 4. Standardization of risk transfer treatment across the boundary Limits and regulatory capital protocols are introduced on the internal risk transfer of equity and interest rate risk from banking books to trading books. This aligns with protocols already in existence for the transference of credit risk across the boundary. 5. Choice between standardized and internal models approach at the trading desk level FRTB provides more flexibility for the banks to choose between Standardized Approach (SA) and Internal Models Approach (IMA) approaches for capital charge computation at the RTD level. This is a very significant shift from prior environments where this choice was generally made at the bank level.
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6. Change in principal risk parameter from VaR to expected shortfall FRTB framework shifts the basic risk parameter from VaR to expected shortfall (ES) to better capture tail risk, and calibrated over a period of financial stress. 7. Differentiated treatment of liquidity factors FRTB Incorporates the risk of market illiquidity by introducing “liquidity horizons” in the market risk metric and an additional charge for trading desks with exposure to illiquid, complex products. 8. Revised standardized approach FRTB standardized approach framework is sufficiently risk-sensitive to act as a credible fallback to internal models and is still appropriate for banks that do not require sophisticated measurement of market risk. 9. Revised internal model approach FRTB’s internal model framework includes a more rigorous model approval process and more consistent identification and capitalization of material risk factors. This is designed to capture tail and liquidity risks and to improve model granularity by driving approval of internal models down to the trading desk levels. Hedging and diversification benefits will be recognized only when there is empirical evidence that they are effective during periods of stress. 10. Closer alignment between the trading book and the banking book FRTB’s treatment of credit risk involves a differential approach to securitization and nonsecuritization exposures.
managing the impact of FRTB There will be continual modifications and fine tuning of FRTB standards, but it is clear to us that banks that implement FRTB requirements effectively and efficiently will strengthen their competitive positions and not be pushed into expending resources to create avenues for regulatory arbitrage and take undue risks that may be latent from their own view. Historically this has been a general response to more rigorous regulation to maintain return on capital. FRTB is designed to prevent this. For banks and institutions with legacy frameworks, budget constrained resources and a kick-the-can culture, the requirement to adopt FRTB also represents a significant opportunity for risk management and technology functions to seek required budget outlays to undertake this transformation.
i / i Based on 4 BCBS QIS studies found in the Impact analysis (section 4) of the FRTB explanatory notes found here http://www.bis.org/bcbs/publ/d352_note.pdf According to the QIS studies, revised capital requirements are likely to be 40% higher on a weighted average basis, including all exposures.
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author Sanjay Sharma, Ph.D. Sanjay is the Founder and Chairman of GreenPoint Global – a risk advisory, technology, education, legal and compliance services firm headquartered in New York. Founded in 2006, GreenPoint has grown to over 350 employees and over 40 consultants with a global footprint. During 2007-16 Sanjay was the Chief Risk Officer of Discretionary Capital Group and Managing Director in Fixed Income and Currencies Risk Management at RBC Capital Markets in New York. His career in the financial services industry spans over 25 years during which he has held investment banking, risk management and technology transformation positions at Goldman Sachs, Merrill Lynch, Citibank, Moody’s and Natixis. Sanjay is the author of “Risk Transparency” (Risk Books, 2013) has also published several papers. He is an Adjunct Professor at New York University and Fordham’s quantitative finance programs, and financial markets program at EDHEC in Nice, France. He has served as the Founding Director of the RBC/ Hass Fellowship Program at the UC Berkeley, and a member of the Board of Directors of UPS Capital (a Division of UPS). He serves on the Global Board of Directors for Professional Risk Managers’ International Association (PRMIA). He holds a Ph.D. in Finance from New York University and an MBA from the Wharton School of Business, and has undergraduate degrees in Physics and Marine Engineering.
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PRMIA names 2017 Canadian Risk Manager of the Year PRMIA is pleased to announce that Richard Di Gioacchino, Vice President, Trade Floor Risk Management, Scotiabank has won the 2017 Canadian Risk Manager of the Year Award. The PRMIA Canadian Risk Manager of the Year Award is given to the Canadian who best: • Practices risk management or advances risk management theory in Canada • Shows leadership in the area of risk management • Advances the study and application of risk management • Mentors individuals in the field of risk management.
The award was presented to Mr. Di Gioacchino at the PRMIA 2017 Canadian Risk Forum. Richard was been working at Scotiabank for the past 18 years and has been a risk manager since 2001. Over that time, Richard has taken on many different leadership roles and brings a wealth of experience to the Global Risk Management division within Scotiabank. His past roles include being responsible for Value at Risk, stress testing and trading risk oversight with Scotiabank. He is currently managing a team that provides oversight over Scotiabank’s equity, commodity and foreign exchange trading businesses globally. While fulfilling second line of defense responsibilities, Richard’s team has been recognized as a value added partner to the trading business. His team has focused on going beyond its traditional governance role so that the risk management function can provide tangible value to front line staff. Richard also acts as a mentor to many risk managers both inside and outside Scotiabank. In addition, he is actively involved with multiple programs at Toronto schools where he helps interested students prepare for a career in the field. Richard has an Honours Bachelor of Commerce degree from McMaster University and a Masters of Business Administration from the Schulich School of Business at York University 044
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PRMIA Canadian risk forum Lively discussion at the Canadian Risk Forum energizes risk community November 13-15 2017, PRMIA Montreal proudly hosted the 5th edition of the Canadian Risk Forum at the historic Ritz Carlton. The event was a huge success, as more than 200 risk and finance professionals gathered in Montreal to hear 60+ leading experts from Europe, USA and Canada tackle the different issues and challenges facing the risk management community. It was a real treat. In fact, this year’s theme – Risk Management 3.0 – Managing the knowns and the unknowns – came to address the drastic changes the financial ecosystem has been exposed to. As a matter of fact, we have noticed that financial and risk practitioners have witnessed the emergence of a changing regulatory overhaul, disruptive technologies, multifaceted management environments, and shocking shifts in the political landscape. These changes entail investment and risk professionals to adapt a nimble mindset long-term. Within this context, new requirements are emerging both in terms of human skills and risk management expertise. Being aware of these challenges, the Canadian Risk Forum committee came up with a well-tailored program with the aim to cover all of these challenges and has identified the crucial need of including “soft skills” panels. In such sessions, discussions were directed toward company risk culture, developing leadership skills for risk managers, and how companies can attract talent and develop skills to grow the next CRO from within.
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One of the key characteristics of the 2017 Canadian Risk Forum was the quality of speakers and the diversity of attendees. Senior speakers and attendees with different backgrounds are only a pure confession of the perfect combination of richness and pertinence of topics.
2017 will always be the synonym of success for the Canadian Risk Forum. In fact, an unprecedented number of attendees, diversified topics and deep discussions are only few of the features characterizing this Forum. We strongly believe that such success wouldn’t have been possible without the support of our sponsors: KPMG (Platinum sponsor), IFSID, PwC and SAS (Gold sponsors), AxiomSL, Chappuis Halder & Co., IBM and Murex (Silver sponsors) and AIMA and CFA Montreal (supporting organizations). Thank you to all of these companies. At PRMIA, we believe that this is only the beginning. Stay tuned for more details regarding the future editions of the Canadian Risk Forum, coming soon ‌
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PRMIA partner news
by Andy Zhulenev “Banking executives can learn a lot from Silicon Valley’s innovators and disruptors” We live in a fast-changing world with new products and services launched daily. While change has become commonplace, this is just a breeze before the storm - a tsunami of emerging technologies is quickly coming at us. These new technologies open amazing opportunities, with the potential to alter businesses in ways we could never imagine, with results we never knew were achievable. The following outlines the key challenges businesses are facing today and why innovation is so crucial for companies’ continued success in banking.
the fourth industrial revolution We are at the beginning of a “fourth Industrial Revolution” with the world moving towards cyber-physical systems where one can 3D-print any product from a digital design; human DNA can be modified to avoid genetic diseases; and the aging of the human body can be slowed down, stopped completely and eventually even reversed. When we are some 20 - 30 years away from such major technology breakthroughs, every industry is going to be disrupted in the coming years, leaving no stone unturned. The driving force behind all this is the unstoppable exponential nature of technology advancements – same as Moore’s Law in the superconductor space. Digital technology is taking a leading role around the world as already apparent on retail store shelves and new digital customer experiences. Physical and Biological worlds are going to follow the Digital world shortly. One thing is clear: every company needs to stay on top of new technological developments impacting their own industry as well as those of their customers. With shortening life-spans of products and even industries, a business cannot be a one-product or even a one-industry enterprise. The only way to succeed in this quickly changing world is to become a portfolio of businesses, each at different stage of its own development, such as experimental startups, small but growing operations, and mature “cash-cow” businesses. Amazon operates on this model already. New ideas are tested through independent, startup-like entities, and successful ones continue to operate completely independently, with full operational control. For that same reason, Google recently reorganized itself from one company into the holding company Alphabet, with multiple independent businesses and a research arm. What has become the way of doing business in technology will now expand into other industries like financial services, manufacturing, healthcare and agriculture. Intelligent Risk - December 2017
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the future of banking While the banking industry is going thru digital transformation, it is only at the very beginning of the actual disruption. Closing branch offices is only the tip of the iceberg. Consumer lending is increasingly relying on the digital profile of the customer, moving away from traditional credit scoring models. Technology leaders and FinTechs who have access to such data already entered the commercial lending business and compete for the best customers with traditional banks. Blockchain, cryptocurrencies and digital valets are redefining the world of payments. Very soon paper money and checks will be taken completely out of circulation, and banking could follow music and media industries on the path to complete digitization. New entrants will likely take away a portion of the pie and traditional players will need to embrace new business models to survive. New startup solutions are usually first adopted by underserved user populations, often in developing countries, before they move into mainstream markets and push traditional players out of business. One example is China, with a high adoption of digital wallets and digital persona-based credit risk assessment methods. It’s only a matter of time before these solutions become mainstream in developed markets as well. The Banking industry is unique in the sense that every other industry is a commercial customer, every consumer is a retail customer. The disruption of the other industries will make many corporations vulnerable, some of them will go bankrupt, certain products may lose in value faster than the term of the loan, and house prices may follow a different trajectory impacting the health of mortgages.
corporate innovation best practices To succeed in this high-velocity world, businesses not only need to understand the ongoing industry disruption but also identify new opportunities early on and expand into new domains far more dynamically. Professional Risk Managers’ International Association (PRMIA) partnered with Silicon Valley Innovation Center (SVIC) to enable its members better access to thought leadership information about financial services industry disruption and corporate innovation best practices. SVIC team of innovation specialists is consulting companies on their innovation journey leveraging unique expertise of entrepreneurs and industry experts in Silicon Valley, and have executed hundreds of highly successful immersion programs in Silicon Valley over the last seven years. Silicon Valley turns out to be the best place to learn about new technologies and industry disruptions. It is the world’s biggest innovation ecosystem, with over 15,000 startups, more than 2,000 venture capital firms, multiple startup incubators and accelerators, universities, research labs, large-scale technology companies, and innovation outposts of industrial corporations. This region captures 28% of all early-stage investments into startups globally, and produces over 38% of startup exit value (Global Startup Ecosystem Report 2017). 048
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The specific FinTech conferences, events and programs organized by SVIC help banking executives understand the ongoing industry disruption, learn more about the innovation culture prevalent today in startups and technology leaders and get familiar with corporate innovation best practices of peers in the industry. Participants meet with the most innovative startups and technology companies, venture capital and angel investment firms, and spend time at a startup accelerator to learn about the latest innovations in the industry happening today. These events have a unique educational and inspirational impact. They not only provide cutting-edge knowledge about innovation trends and strategic frameworks, but also create a lasting motivational effect. At the end of the program, participants are full of excitement and energy to come back to their own organizations and lead their company’s transformation agenda.
author Andy Zhulenev Andy Zhulenev is Vice President at Silicon Valley Innovation Center (https://siliconvalley.center/). The center’s mission is to help corporations from around the world to discover upcoming technology trends, understand industry disruptions and accelerate their corporate innovation journey by engaging with groundbreaking startups.
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calendar of events The first several months of 2018 feature a full schedule of Virtual Training Courses. Mark your calendar now and visit www.prmia.org/events for more information.
EFFECTIVE REGULATORY CHANGE MANAGEMENT January 16
CYBER RISK REGISTER: THE CORNERSTONE FOR MANAGING CYBER RISK January 25
KEY COMPONENTS OF AN ANTI-MONEY LAUNDERING PROGRAM February 8
COMBATING TERRORIST FINANCING February 22
FRAMEWORK AND TAXONOMY FOR OPERATIONAL RISK February 28
RISK APPETITE STATEMENTS AND TOLERANCE LIMITS March 7
ANTI-MONEY LAUNDERING: SUSPICIOUS ACTIVITY REPORTING March 8
ASSOCIATE PRM CERTIFICATE EXAM SERIES March 13 – May 8
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A MODERN REPRESENTATION OF RISK & CONTROL SELF ASSESSMENTS March 14
SCENARIO ANALYSIS: SIMPLE METHOD FOR QUANTIFYING RARE EVENTS March 21
IMPLEMENTING OPERATIONAL RISK WITHIN AN ERM FRAMEWORK March 22
SIX STEPS TO DEFINE AND DESIGN PREVENTIVE KRIS March 28
OPERATIONAL RISK MANAGEMENT FOR PROJECTS April 4
DRIVES & REGULATIONS FOR MODEL RISK MANAGEMENT April 5
INFO. SECURITY ASSESSMENT AND ESSENTIALS OF CYBER PROTECTION April 11
MODEL GOVERNANCE & MODEL RISK MANAGEMENT FRAMEWORK April 12
CONDUCT AND CULTURE: MEASUREMENT & MANAGEMENT April 18
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INTELLIGENT RISK knowledge for the PRMIA community ©2017 - All Rights Reserved Professional Risk Managers’ International Association