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Derivatives Valuation and Margin CalculationsWEBINAR | 27TH FEBRUARY 2018| 3PM GMT / 10AM EST
2
Agenda
Welcome Ian Blance | Voltaire Advisors
1005 - 1015 Introduction: The ISDA SIMM | Ian Blance, Voltaire Advisors
1015 - 1030 ISDA SIMM: Derivatives Valuation & Margin | Dr. Russell Goyder, FINCAD
1030 - 1045 Initial Margin Under EMIR | Marc-Louis Schmitz, Finalyse
1045 - 1100 Audience Q&A
1100 Close of Webinar
3
Introduction: The ISDA SIMMIan BlanceManaging DirectorVoltaire Advisors
4
Background
u SIMM introduced by International Swaps Dealers Association (ISDA) in 2013 in response to financial crisis
u Live in September 2016
u Applies to non-centrally cleared over-the-counter (OTC) derivatives
u Standardized derivatives centrally cleared
u Part of a package of reforms to reduce systemic risk from OTC derivative markets
u Broader regulatory context increasingly complex and challenging for derivatives traders and users
5
SIMM
u Goal is to establish standard method for calculation of Initial Margin (IM) for non-centrally cleared OTC derivatives
u Consistency of application in wide variety of market participants
u Reduction in disputes over margin calculations
u Step 1 – Decompose portfolio into risk factors
u Step 2 – Calculate IM requirements
u Superficially fairly simple maths
u Subject to revision – Version 2.0 in December 2017
6
Challenges
u Data inputs – especially sensitivities
u Manual collateral processes
u Dispute definition and resolution
u Alternatives – Basel Committee approach
7
ISDA SIMM –Derivatives Valuation & Margin
Dr. Russell Goyder, Director of Quantitative Research and DevelopmentFINCAD
© FINCAD
ISDA SIMMDerivatives valuation and margin
February 27, 2018
© FINCAD2
Russell Goyder, PhD, is the Director of Quantitative Research and Development at FINCAD. Before joining FINCAD's quant team in 2006, he worked as a consultant at The MathWorks, solving a wide range of problems in various industries, particularly in the financial industry.
In his current role, Russell manages FINCAD's quant team and oversees the delivery of analytics functionality in FINCAD's products, from initial research to the deployment of production code. Russell holds a PhD in Physics from the University of Cambridge.
Russell Goyder, PhDDirector, Quantitative Research and DevelopmentFINCAD
© FINCAD
Agenda
Challenges1
Best practice2
Conclusion3
© FINCAD
Agenda
Challenges1
Best practice2
Conclusion3
© FINCAD
SIMM Structure
Standardized Sensitivities
Prescribed Weights and Correlations
SIMM Calculator Initial Margin
© FINCAD
garbage in
© FINCAD
© FINCAD
garbage out
© FINCAD
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
© FINCAD
Collateral optimization
Need for speed
Counterparty selection
Pre-trade analysis
TODO better for this to be an image conveying idea of need for speed with the text on top?
Collateral optimization
Counterparty selection
Pre-trade analysis
the need for speed
© FINCAD
© FINCAD
bump and grind
© FINCAD
© FINCAD
horizontal scaling
© FINCAD
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
© FINCAD
Risk ladders are not standardized
CashFRA orFutures
Swaps
Basis Swaps
Cash
Swaps
© FINCAD
Synthetic market data
Market instruments
Calibrate
Price
Standardized instruments
Pricing model Standardized model
© FINCAD
TODO Everest image or something to make the point that it is hard?
hard to get there
© FINCAD
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
© FINCAD
a patchwork of pricers
© FINCAD
© FINCAD26
TODO image for impossible to put back together like humpty or shattered glass
© FINCAD
the numbers don’t add up
© FINCAD
Agenda
Challenges1
Best practice2
Conclusion3
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
Algorithmic Differentiation
Risk Reprojection
Analytics Platform
Best practice
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
Algorithmic Differentiation
Risk Reprojection
Analytics Platform
Best practice
© FINCAD
the past
© FINCAD
© FINCAD
current.
AlgorithmicDifferentiation
© FINCAD
the future
© FINCAD
© FINCAD
0
5000
10000
15000
20000
25000
30000
35000
40000
0 37 74 111
148
185
222
259
296
333
370
407
444
481
518
555
592
629
666
703
740
777
814
851
888
925
962
999
1036
1073
1110
1147
1184
1221
1258
1295
1332
1369
1406
1443
1480
1517
1554
1591
1628
1665
1702
seco
nds
# of risk factors
Cost of Risk - UAD v.s. Bumping
UAD Bumping Best Fit
© FINCAD
0
2
4
6
8
10
12
Porfolio IR Swaps Swaptions CDS FX Forwards Caps and Floors Equity Options FX Options
mill
iseco
nds
Cost Per Trade
Value Risk
© FINCAD
0
20
40
60
80
100
120
140
160
180
American Options TARF Basket Options
mill
iseco
nds
Cost per Trade - Exotics
Value Risk
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
Algorithmic Differentiation
Risk Reprojection
Analytics Platform
Best practice
© FINCAD
Risk Reprojection
Portfolio (netting set)
Standardized Instruments
Market Data
1
2
3
© FINCAD
reprojected sensitivities
© FINCAD
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
Algorithmic Differentiation
Risk Reprojection
Analytics Platform
Best practice
© FINCAD
© FINCAD
© FINCAD
© FINCAD
© FINCAD
© FINCAD
© FINCAD
Analytics Platform
Analytics Platform
Services API
Distributed Calculations
Caching Data Integration
Admin Data Storage
Python/Excel Other ApplicationsPortfolio and Risk
Portfolios Market Data Reference Data
© FINCAD
Agenda
Challenges1
Best practice2
Conclusion3
© FINCAD
ChallengesSpeed of sensitivity calculation
Portfolios and nettings sets
Standardized sensitivities
Algorithmic Differentiation
RiskRe-projection
Analytics Platform
Best practice
© FINCAD
Enterprise portfolio and risk analytics for multi-asset derivatives and fixed income.
Out of the box, and customizable - No compromises
Improved Decision MakingFosters collaboration from creating ideas for investment strategies, through trading, to ongoing risk management.
Shared Data and AnalyticsConsistent input data and analytics for consistent results from front to middle office, reducing reconciliation issues and disagreements
Transparent and FlexibleTrace the lineage of results supported by a full audit trail of changes. Customizable analytics and reporting.
© FINCAD
“F3 is the most flexible valuation and risk analytics solution on the market that we could find. the ability
to develop and implement highly tailored hedging strategies and produce intra-day risk has been
extremely valuable for our team.”
− Senior Manager, Portfolio Management, UK Pension Scheme
© FINCAD
© FINCAD
FINCAD is the leading provider of enterprise portfolio and risk analytics for multi-asset derivatives and fixed income. An industry standard since 1990, our advanced analytics, flexible architecture and patented technology enable financial institutions to make better investment and risk decisions. Our goal is to provide our clients with solutions that help them achieve their goals, with no compromises. Clients include leading global asset managers, hedge funds, insurance companies, pension funds, banks and auditors.
For more information:North America 1 800 304 0702
Europe00.800.304.07020
52
Initial Margin Under EMIR
Marc-Louis SchmitzPartnerFinalyse
Brussels I Amsterdam I Luxembourg I Budapest I Warsaw
Finalyse Valuation Service
Initial margin under EMIR
Marc-Louis Schmitz27/02/2018
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
To regulate the OTC derivatives market following the 2008 financial crisis. In particular:
• Reduce the counterparty risk• Improve transparency• Mitigate the systemic risk• Reduce the operational risk• Prevent future financial system
collapses
Clearing
Reporting Risk mitigation
Why EMIR? What does the EMIR cover do?
54
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
ü Payment made to the counterparty on a daily basis to cover the current exposure of derivatives contracts. In the case of OTC derivatives, it should be equal to the positive mark-to-market value.
ü Calculated and exchanged daily (subject to MTA).
Variation Margin
ü Payment made to cover a potential exposure during the time between the last exchange of the variation margin and the liquidation of the position following a default of the counterparty: typically 10 days with 99% of confidence.
ü Rarely in use before EMIR
Initial Margin
55
Both counterparties that have (or belong to groups which have) an aggregate average notional amount of non-centrally cleared derivatives above…
…should comply with the initial margins by the date specified above.
Under EMIR there are exemptions from the margin requirements for intragroup transactions (provided certain conditions are met).
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
1st September
2020
1st September
2019
1st September
2018
1st September
2017
4th February
2017
EUR 3,000 bn EUR 2,250 bn EUR 1,500 bn EUR 750 bn EUR 8 bn
56
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
• Notional weighted according to the asset class and added up.
• May lead to unnecessarily large and costly requirements on capital.
• As it treats all securities of given class equally, it does reflect the risk of more exotic securities.
• Simple
• But is “Hammer to kill the fly” for most who have reasonably safe securities.
Asset Class IM (% of Notional)
Credit (0-2) years 2%
Credit (2-5) years 5%
Credit 5+ years 10%
Commodity 15%
Foreign Exchange 6%
Interest Rate (0-2) years 1%
Interest Rate (2-5) years 2%
Interest Rate 5+ years 4%
Other 15%
57
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
• Counterparties are allowed to develop their internal model.
• Internally tailor-made for the securities and the exposures actually being held.
• Accounting for their sensitivities and covariance's within portfolio.
• Number of modelling options (under some prescriptions)
• Costly model development and governance.
Comparison Internal Model
Schedule-based Method
Representation of exposures
Tailor made to represent the exposures
Made to represent generic (risky) exposures
Capital Burden Capital reflects the exposures
Unduly high capital requirement
Modelling difficulties
Complicated model development
Easy to use
Agreement with counterparty
Counterparties will need to agree on models.
Standardized
Supervision Needs to be approved
Comes from supervisors
58
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
An attempt to make the best of the two worlds :
• Licensed and maintained by ISDA
• New version in Dec 2017• Ease of replication• Transparency• Good calculation Speed• Extendibility to new risks• Predictable capital allocations
Comparison Internal Model
Schedule-based Method
ISDA SIMM
Representation of exposures
Taylor-made to represent the exposures
Made to represent generic (risky) exposures
Is accurate in representing the exposures
Margi Burden Margin reflects the exposures
Unduly high Margin requirement
Margin reflects the exposures
Modelling difficulties
Complicated model development
Easy to use Development and governance taken over by ISDA –user friendly.
Agreement with counterparty
Counterparties will need to agree on models
Standardized Depends on the large level of consensus
Supervision Needs to be approved
Comes from supervisors
Is approved
59
23By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
60
• May lead to a substantial decrease in initial margin requirements (as much as five fold for some of the benchmark portfolios).
• Offsets sensitivities of different deals within the risk classes.
• Accounts for diversification across risk classes (via the use of correlations in the aggregation) within each product class.
Nevertheless, ISDA SIMM does not cover the calculation of sensitivities themselves, and different models produce different sensitivities, so not all disputes will be avoided.
ISDA SIMM: Best solution
• Parties with long-dated trades that always follow the same direction
• Denominated in high volatility currencies.
Ø In those cases (and those cases alone) the schedule-based methodology may be simplest and most efficient.
Ø In all other cases: ISDA SIMM is likely to be preferable
For whom the ISDA SIMM may NOT be desirable
Based on a parametric VaR 10 days 99%.• Steps:
1. Valuation and greeks (Delta, vega, curvature) for each position2. Greeks will ideally be produced under CRIF (Common Risk Interchange Format)Ø The results of those two steps will depend on the model and market data
61By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
TradeID ProductClass RiskType Qualifier Bucket Label1 Label2 AmountAmount
CcyXXX1 Credit Risk_CreditQ 7BED48 1 3Y 2,073 EURXXX2 Credit Risk_CreditQ 7BED48 1 5Y 27,968 EURXXX3 Credit Risk_CreditQ 7BED48 1 10Y 0 EURXXX4 Credit Risk_FX USD 7,001 EURXXX5 Credit Risk_IRCurve USD 1 2W Libor3m 0 EURXXX6 Credit Risk_IRCurve USD 1 1M Libor3m 0 EURXXX7 Credit Risk_IRCurve USD 1 3M Libor3m -1 EUR
– Risk weights and Aggregation
– Review every 10 days or after specific events– Bilateral– Back testing vs P&L
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
ProductClass
Initial Margin (IM)
RiskClassInterest
Rate Credit
(Qualifying) Credit (Non-Qualifying)
Equity Commodity FX
RatesFX 6,174,955 4,469,771 - - - - 3,221,217 Credit 2,530,838 5,948 2,511,539 - - - 62,146 Equity 2,717,771 108 - - 2,717,752 - -
Commodity - - - - - - -Total 11,423,564
62
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
• Same logic of parametric VaR
• 4 risk classes, IR, FX, EQ, CO
• Both rely on delta and vega“greeks”
• Some of the requirements overlap, leading to lower costs
Similarities
• Credit is split across 2 risk classes in SIMM (qualifying/non-qualifying), 3 risk classes in FRTB (securitization, non-securitization, correlation trading).
• SIMM computes curvatures and transformation of vega, FRTB requires additional sensitivity to be calculated.
• SIMM does not allow offset between sensitivities in the same risk classes across different product classes.
• SIMM has two additional interest rate buckets.
• Weights and correlations are different.
Differences
63
By no means does FINALYSE accepts any responsibility for the content of this presentation, it’s provided for information only.
• Valuation of derivatives (and derivation of sensitivities) will be a key issue (on which the parties will need to agree) for both VM and IM
• Reconciliation and disputes resolution
• Difficulties to compute the exact profitability of each trade (MVA)
• Identification, separation and management of both legacy trades and newly compliant trades in large portfolios
• Review of the CSA
• Collateral management
Challenges
64
Finalyse, a European-wide leading consultancy, was founded in
1988. The company has a demonstrated expertise in
valuation, risk management & regulatory compliance advisory,
providing the financial community with the expertise bridging
the gap between finance and technology.
At Finalyse we value expertise, team spirit, empowerment,
fairness and innovation.
Risk Advisory
Assistance in choosing and implementing the best solutions to measure, report and manage your risks.
Regulatory Compliance
Guidance and up-to-date solutions to comply with evolving regulatory requirements, such as PRIIPs, EMIR, Basel III/CRD IV, Solvency II, MiFID II, AIFMD.
Valuation Services
An independent, cost-effective and tailored service for the valuation and reporting of OTC derivatives and structured products. SIMM Licenced Vendor.
65
66
Audience Q&A
67
Thank You!
u Participants will receive a copy of the slide deck and a recording of the Webinar tomorrow.
u Webinar and associated Guide is part of our Current Issues in Valuation Series looking at topical pricing challenges
u This is a component of our VIVA program of fund valuation initiatives throughout 2018 – more details can be found here:
http://www.voltaireadvisors.com/viva.html
68
Contact Us
Voltaire Advisors LLP
14 Wall Street No.1 PoultryNew York London
NY 10002 EC2R 8JRUSA UK
+1 800 317 1932+44 800 677 1694