counterparty credit risk in financial institutions · counterparty credit risk in financial...
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Counterparty Credit Risk in Financial Institutions
Ivan Sergienko Director, Counterparty Credit Risk Measurement
University of Waterloo, 4 February 2014
2 GLOBAL RISK MANAGEMENT
My previous research
About Scotiabank
Review of a simple transaction: Market Risk vs Counterparty Credit Risk
Counterparty Risk Measures: PFE, Expected Exposure, CVA, Capital
Mitigation of counterparty credit risk: Netting, Collateral
CCR System at Scotiabank
Outline
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Past Research
Memorial University of Newfoundland 2002-2004
Oak Ridge National Laboratory, 2004-2007
Non-centrosymmetric superconductors
Magnetoelectric materials
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From Science/Math/Eng to Finance
Options:
• Quant Finance Programs:
o Prepare you for day 1 and beyond. o Don’t do if you have a PhD.
• CFA®: o Targeted for stock analysts, investment bankers. o Broad business knowledge/accounting.
• FRM®: o Focus on statistics, derivatives. o Very quantitative.
• MBA: o Broad business knowledge/strategy. o Need good school ($$$$).
Programming a must!
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About Scotiabank
1832 – Founded in Halifax with a capital of £100,000
1889 – Branch in Jamaica
1897 – Branch in Toronto
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Scotiabank Business Lines
18%
22% 34%
26%
Net Income
Global Wealth &Insurance
Global Banking &Markets
Canadian Banking
International Banking
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Market Risk
Client (NG producer)
$ x
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Market Risk
Client (NG producer)
$ x
Bank
$ x
$ 4.00
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Market Risk
Client (NG producer)
$ x
Bank
$ x
$ 4.00
Market
$ x
$ 4.10
Client: x + (4.00 – x) = 4.00 Bank: (x – 4.00) + (4.10 – x) = 0.10 Market: x – 4.10 - Market Risk Taker
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Counterparty Credit Risk
Client (NG producer)
Bank
Market
$ x
$ x
$ 4.00
$ x
$ 4.10
Client: In default Bank: 0∙(x – 4.00) + (4.10 – x) Market: x – 4.10
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Counterparty Credit Risk
Bank
Market
$ x
$ 4.10
Assume: x = 5.00 Bank: 0∙1.00 + (- 0.90) = - 0.90 Market: 0.90
Assume: x = 3.50 Bank: 0∙(-0.50) + (0.60) = 0.60 Market: - 0.60
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Counterparty Credit Risk Concepts
-3 -2 -1 0 1 2 3 4 5
-10
-5
0
5
10
15
Millio
ns
possible future
paths PFE
profile
expected
exposure profile
expected MTM
profile
history of
MTM
PFE
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
-10 -5 0 5 10 15
MTM
Exposure
90% Tail
E[MTM] EE
PFE
t = 3 y
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Counterparty Credit Risk Concepts
-3 -2 -1 0 1 2 3 4 5
-10
-5
0
5
10
15
Millio
ns
possible future
paths PFE
profile
expected
exposure profile
expected MTM
profile
history of
MTM
PFE
E[MTM] – Rarely interesting
EE – used in:
o CVA – cost of risk (PD adjusted)
o Capital requirements
o DVA, FVA, etc.
PFE – used for limit monitoring
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Counterparty Credit Risk Concepts
-3 -2 -1 0 1 2 3 4 5
-10
-5
0
5
10
15
Millio
ns
possible future
paths PFE
profile
expected
exposure profile
expected MTM
profile
history of
MTM
PFE
E[MTM] – Rarely interesting
EE – used in:
o CVA – cost of risk (PD adjusted)
o Capital requirements
o DVA, FVA, etc.
PFE – used for limit monitoring
0
100
200
300
400
500
600
700
PFE profile
Limit
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Counterparty Credit Risk Concepts - Netting
If you owe me $100, and I owe you $60, don’t you just owe me $40?
Not always!
-
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
4/2/2013 4/2/2014 4/2/2015 4/2/2016 4/2/2017
PFE (Non-netted)
PFE (Netted)
Trade 1: CAD$100M, 5 year Single Currency Swap (CAD) Trade 2: USD$100M, 1 year FEC (CAD/USD)
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Counterparty Credit Risk Concepts - Collateral
Profile decreases dramatically with a margin agreement. Model assumes collateral at any point in time equals the MTM some time previously.
-3 -2 -1 0 1 2 3 4 5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Mill
ion
s possible future paths
PFE profile expected exposure profile
expected MTM - Collateral
history of MTM
-3 -2 -1 0 1 2 3 4 5
-10
-5
0
5
10
15
Millio
ns
possible PFE
expected
expected MTM
history of
PFE
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Counterparty Credit Risk Concepts - Collateral
Trade 1: CAD$100M, 5 year Single Currency Swap (CAD) Trade 2: USD$100M, 1 year FEC (CAD/USD)
-
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
4/2/2013 4/2/2014 4/2/2015 4/2/2016 4/2/2017
PFE (Non-netted)
PFE (Netted)
PFE (Netted + 0 TH CSA)
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Counterparty Credit Risk System at Scotiabank
In collaboration with IBM Risk Analytics/Algorithmics.
Trading systems
Trades, Market prices
Collateral system
Counterparty operations
Algo
Credit
Collateral data
Risk reports
Netting setup Credit ratings
Trading systems
Trade
Algo
Credit
Incremental Risk Measures
End of day
architecture
Intra-day
architecture
Best Counterparty Risk Initiative
American Financial Technology Awards
2010
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Counterparty Credit Risk System at Scotiabank
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Questions?
Thank you for your time.
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Abstract
Counterparty credit risk (CCR) management of today is a complex process
involving many groups within financial institutions. I will describe Scotiabank’s
award winning CCR initiative . I will review basic CCR concepts and explain
how CCR measures are calculated. I will also talk about my career
experience in science and financial industry.
Bio Ivan Sergienko is Director, Counterparty Credit Risk Management at
Scotiabank. He leads implementation of a comprehensive CCR framework
covering major derivatives types. Before joining Scotiabank in 2007 he held
research positions at Memorial University of Newfoundland and Oak Ridge
National Laboratory. He hold a PhD in Physics and the Chartered Financial
Analyst® designation