by ·Comments Off on Understanding Commodities Risk – in print March 2010

Understanding Commodities Risk – out in print early March 2010


The principles are simple. Document the supply and demand of a resource, the psychology of its market and participant behaviour and you should have a handle on how prices move. Identify any leading indicators and your price prediction model is complete.

Interesting enough while commodities markets are older than time, at the user level price movement in this group is not as well understood as stocks and bonds. While each commodity is unique and to some extent interlinked with broader trends in oil, gold and currencies, analyst coverage is not as common or as deep as we would want. Till about two years ago this was acceptable since markets would spike and prices would shoot on account of supply and demand pressures and when an aggressive player was trapped in a short squeeze in a given market at a time. But all of this changed with the arrival of 2008, with 147 dollar oil, 1200 dollar gold, correlations and volatilities that could downshift before you could even spell the word sell.

In this edition of commodity risk, we have tried to answer five specific questions

  1. What are the relevant and credible drivers behind price movement of oil?
  2. What is the relationship between Australian dollar and gold?
  3. How have correlations and volatilities changed between 2008 and 2009?
  4. What is the real rate of interest in the Indo-Pakistan subcontinent? How closely are these two markets linked?
  5. How are price movements in oil related to other commodity groups? How does this analysis extent to Palm oil?

 

We start with a look at Oil, Gold, Natural Gas, Interest Rates and the Australian dollar. We look at the dynamics and the drivers behind these five groups and the one currency that is looked at as a leading indicator both for price movements and correlation. To this mix we add edible oil (Palm oil), inflation and interest rates in the region as well as examine the changing trend in correlations. Interest rates, real rates and inflation allowed us to examine inflation hedge effectiveness as well as document inflation adjusted returns.

by ·Comments Off on The Hierarchy of Treasury Limits

For monitoring market risk, the company will need to segment the overall investment portfolio. They may for instance segment the portfolio by product, then trading desk, then trades. For each segment of the portfolio limits will be defined. Generally, limits increase as you move up in the hierarchy. For example market risk hierarchy may be established as depicted below. A risk metric is selected (duration, VaR, etc) and risk limits are specified for each component of the hierarchy based on this metric.

Exceptions

When the stop loss limit is breached the investment will be liquidated as soon as possible. Any exception to this process should be approved at the right authority level within the risk management division. This exception approval hierarchy will generally be based on absolute dollar/dirham amount of loss that can be booked on a position before it should be cut, and will be suggested by the risk management group and approved by the Board Risk Committee.

by ·Comments Off on Product and counterparty limits – what is at risk?

For instruments that trade and are re-priced on a daily basis we need to consider the interaction of credit risk (a counterparty default) and price risk (the risk that the market has moved against us).

What happens when a counter party defaults on settlement when

  1. He has to deliver a bond that you have purchased and
    1. bond prices have moved downwards
    2. bond prices have moved upwards

       

  2. He has to take delivery of a bond that you have sold and
    1. bond prices have moved downwards
    2. bond prices have moved upwards

     

  3. Do we have the same exposure on a derivative contract? Interest Rate Swaps and Cross Currency Swaps
  4. He has to deliver Euros that we have purchased and
    1. US$/Euro Exchange rate has appreciated in favor of Euro
    2. US$/Euro Exchange rate has appreciated in favor of US$

     

  5. Do we have the same exposure on option contract?

     

  6. How do we calculate Potential Future Exposure?

Counterparty Limits – Measuring Exposure

Counterparty limit setting process can be broken down into two categories.

The first is the Financial Institution (FI) limit setting process which is dealt with through the FI function.

The second is a customer limit which is treated and calculated in the same manner as allocation of credit to corporate customers.

The FI limit setting process entails setting limits depending on:

  • Issuer’s credit rating (limits set on issuer based on credit rating)
  • Analysis of its financial health and strength, including capital adequacy, asset quality, earnings/ profitability, liquidity position, cash flow generation capacity, liquidity, ratios (limits set based on acceptable levels for financial ratios).
  • Institution profiles, such as the history, nature of business, types of business, product offerings, branch network and compliance with KYC (limits set based on acceptable benchmarks for each characteristic)

The FI limit setting process may also be product specific.

For a corporate customer, especially on derivative contracts, the primary question on a given transaction is Potential Future Exposure. How much money can the bank lose if the customer defaults on settlement? And is there anything the bank can do to secure that exposure?

by ·Comments Off on Operational and additional Transactional limits

Besides stop loss limits discussed above the following limits should also be set:

Inventory age limits

Inventory age limits set the time for which any security is held without being sold. This is to prevent traders from sitting on illiquid positions or positions with an unrecognized loss. The time allowed will depend on the overall purpose of the desk. If the desk is expected to trade in and out of the position quickly, the limits will be on the order of days. If the desk is expected to use long-term strategies then the limit can be on the order of weeks or months.

Concentration limits

Concentration limits prevent traders from putting all the eggs in one basket. They ensure that the traders risk is not concentrated in one instrument or market. For example the equity desk may be limited to a maximum of 3% in any one company. This may also be subject to a limit on total percentage of that company’s equity that may be held.

by ·Comments Off on Loss Capital and Stop Loss Limits

Capital Loss & Stop loss limits

Stop loss limits act as a safety valve in case something starts to go wrong. Stop loss limits state that specified action must take place if the loss exceeds a threshold amount. Tight stop loss limits reduce the maximum possible loss and therefore reduce the capital required for the business. However, if the limits are too tight they reduce the trader’s ability to make a profit.

The first step in setting stop loss limits is to determine the appetite of the company regarding its risk tolerance. This translates to specifying the amount of capital that the company can afford to lose.

The following elements would need to be considered when determining the capital loss amount.

  • The expected rate of return that will be earned on the capital will the next twelve month period.
  • The rate of return that will be required to satisfy shareholders.

by ·Comments Off on Risk Limit Management Philosophy

Basic Principles of Limit Setting

From the book “The Fundamentals of Risk Measurement” by Chris Marrison

  • Ideally limits should be risk based, i.e. the measurement of limit utilization should be directly proportional to the amount of risk taken.
  • Limits should be fungible at lower levels. The trader should be allowed to take risks to exploit the best opportunities available without being too tightly bound by complex limit system. Similarly a senior trader should be allowed to move limits from one subordinate desk to another.
  • The limits should be aligned to the company’s competitive advantages.
  • If a portfolio is to be managed within a given set of limits, it should not be possible for changes in another portfolio to cause the limits for the former portfolio to be broken.
  • Both hard and soft limits need to be set. If the limit is hard then traders know that they will be disciplined or fired for violating the limit. If the limit is soft a violation simply leads to a conversation when the trader is advised to reduce the position.

 

by ·Comments Off on Treasury one – redux

I had no idea that my treasury one post would generate so much traffic and commentary. On a blog where it is rare to see more than a single comment (given all my anti spam, anti bot, anti social word press defenses) in less than 24 hours 8 comments (ok I confess 4 of them were my responses to 4 comments posted by other well wishers) were akin to a system shock. Then Mohtashim posted the Facebook post and before we could even start counting, we had broken the 8 comments barrier on Facebook also.

What is the story behind this product?

In March 2007 armed with some cash in the bank, an investor check and a customer who wanted us to push harder we decided to build a next generation treasury platform. A browser based bank treasury management system with its own treasury accounting GL, paper less workflow and complete integration with the Alchemy Risk product suites. It added four unique features.

  1. Real time transaction dashboards that you could access from anywhere (including your iphone and your black berry) and
  2. Pre trade checks that would stop a ticket from moving further in the workflow if a limit breach occurred.
  3. Coupled with the ability to do desk, dealer, product, customer, region and currency wise profitability the product took care of an enormous list of headaches that Treasurers, TROPS heads and CFO face in mid and large sized banks.
  4. Fully integrated Fixed Income (MM), Foreign Exchange (FX) and Capital Markets (EQ) suites with SWIFT, M3 and FXCRS reporting

Of course all of this was a dream on paper when we started it but it took three years, two driven back office specialists (Salim Lalani and Dilshad Qureshi) over at two customers and four equally inspired Treasurers to bring this platform together.

Why the outpouring of joy, celebration and relief that you have witnessed on this blog and on Facebook? Because just like Alchemy Risk Manager, building Alchemy Treasury One almost killed the firm that built the product…It took three years of sheer pain, disappointment, aggravation, agony, shouting and screaming matches and sacrifices on part of all of us who worked on this product to bring it to a stage where a mid size bank took it upon itself to turn it on last Saturday. Team Alchemy put its heart and soul in, while Mohtashim and I will blame our permanent hair loss to a crazy trip in Bangkok where the first, troublesome treasury one scope and contract document was penned, finalized and emailed to our first customer.

Today when we and our customers see the product at work and we see how it compares to the competition and what it can do and how it simplifies what used to be a exceedingly complex and contentious function, you have no idea how much warmth it creates.

As a good friend put it to me the other day, “the last time someone was crazy enough to build a half way decent back office platform was two decades ago. And the firm that was crazy enough to try it was i-flex. Look what happened to them?”

Stay tuned…

by ·Comments Off on Treasury One goes live at KASB Bank

Our second Treasury implementation that integrates completely with the Misys Equation backend, the Alchemy Risk Manager Middle Office application and SBP M3 reporting requirements. Additional options include the ability to link up directly with the Reuters dealing system top feed and SBP FX-CRS reporting engine.

Took a year and an enormous amount of support from the team and the business users at the customer to make this happen… When I am old and grey, I will write another book about the 3 years it took to implement two treasury platforms at two different banks and how different they were from each other.

For now a big hand to the Alchemy team that over the last three years made it possible to develop and deploy our first paper less, transaction and workflow management platform for midsize and large treasuries in Pakistan. And a big thank you for all members of the extended Alchemy family out there who made this milestone especially memorable.

by ·Comments Off on The TreasuryOne Product line

Alchemy TreasuryOne is an integrated straight-through-processing platform with rich functionality for deal capture, position tracking, risk management and settlement of transactions across all asset classes and instruments. TreasuryOne has been implemented and live at client sites for over a year in Pakistan.

TreasuryOne implements pre-trade checks within a robust paperless workflow across front, middle, and back-office functions. Designed and developed under the guidance of treasury professionals, TreasuryOne increases visibility into treasury activity, reduces trading costs and improves operational efficiency and control.

 

 

 

 

 

 

 

 

TreasuryOne Features

Treasury Desk Summary Overview:

Money Market

Forex Market

Equity Market

Deals Capture and Pricing

Deals Capture and Pricing

Deals Capture and Pricing

Limit Management

Limit Management

Limit Management

Settlement

Settlement

Settlement

Portfolio Management

Multiple Revaluation Methodologies

Portfolio Management

CRR/SLR Tracking

Nostro Management

Position Keeping and Monitoring

Blotter Management

Blotter Management

Blotter Management 

Reports

Reports

 Reports

UQA (Reporting tool for users)

UQA (Reporting tool for users)

UQA (Reporting tool for users)

SBP MMCRS Integrated

SBP FXCRS Integrated

  

MISYS Core Banking Integrated

MISYS Core Banking Integrated

MISYS Core Banking Integrated

STAR Integrated

STAR Integrated

  

SWIFT Messaging

SWIFT Messaging

  

Reuters Rates Import

Reuters Rates Import

Price Feed Import

Detailed Features:

Money Market Front and Middle Office

Tickets

Information Screens

Call / Clean

State Bank Account Blotters Bank level and Treasury level

Repo/Reverse Repo

Maturity Profile (daily)

OMO/Discounting

Maturity Gaps (Long-term and Short-term)

Outright Sale/Purchase

Inventory Book

SARR (Sale Against Reverse Repo)

Inter-Bank Outstanding Deals

Inter-branch (TT)

Inventory Status and tracking

Miscellaneous -Withdrawals/Deposits to SBP

CRR/SCRR metrics tracking

  

Portfolio and deals MTM And revaluation display

  

Profit and Loss Real time display

Workflow

Limits Engine

Four Eye principal input and control for tickets

Ability to Stop ticket on potential limit breach

Ticket return, append ability.

Current Limit Status Screen

Tickets approval limits

Product limits check

Ability to cancel tickets before authorization

Pre trade limits check

Ability to cancel tickets after authorization

Counterparty credit limits

Ability to cancel tickets after day-end
(in certain cases)

Dealer intraday trading limits

  

Approver/Authorizer limits

  

Brokerage authorization control

  

Audit trail to track and display limits positions

  

Ability for temporary enhancement of limits

Others

Middle office analytics
(Alchemy Risk Manager required)

SARR Offset and Monitoring

VAR – Value at Risk reports

Alerts when user logins to system including:


Incremental VAR
  • Maturities

Duration and Convexity
  • HFT (and other alerts)


Instrument pricing calculators
  • Coupons

  

 

Money Market Back Office

Daily Processes

Tickets settlement

Day Start for Money Market

Access to Money Market Tickets

Branch Balances for State Bank Accounts

Deal Verification

Deal Confirmations for multiple deal ticket types

Deal Authorization

Money Market Monitoring (M3) integrated

SGL Prints for certain deal types

Day End for Money Market

Ticket Prints for all deal types

Price feeds upload (automated)

OMO/Discounting Documents’ Prints

Ability to mark status of confirmations received from counter parties

Discounting Annexure

  

SWIFT Message (MT 320)
 

Integration with Core banking

Workflow

Accounting Module (GL)

Four Eye principal input and control for tickets

Automated Voucher Generation

Ticket return, append ability


Daily maturity accounting

Tickets approval limits

Inventory Accounting

Ability to cancel tickets before authorization

Fully detailed Money Market Accounting for all deal types

Ability to cancel tickets after authorization

Day Start/End Accounting

Ability to cancel tickets after day-end
(in certain cases)

Audit Trail for Activity


 

Export of SoC (accounts) reports:

  
  • Brokerage Accounting Manual voucher entry for GL

  
  • Reval Accounting

  
  • Year end accounting

 

FX Front and Middle Office

Tickets

Information Screens

FX Today / Forward / Split

FX Blotter and Deal Monitor

FX Placement & Borrowing

Impact on MM Blotter and SBP Reports

FX Misc (NOSTRO Transfer etc)

Maturity Profiles

FX Swap

FEEL (Runtime)

FX-TMU Import/Export/Remittance

COP Monitoring and Limits

FX-TMU Foreign Bills Purchase

Nostro monitoring

FX-TMU Partial and complete take ups

Swap Profitability calculator

Fx-TMU Closeouts

Maturity Gaps

  

MTM /Revaluation
 

Profit and Loss Realtime display

Workflow

Limits Engine

Four Eye principal input and control for tickets

Ability to Stop ticket on potential limit breach

Ticket return, append ability.

Current Limit Status Screen

Tickets approval limits

Pre trade limits check

Ability to cancel tickets before authorization

Currency limits

Ability to cancel tickets after authorization

Dealer intraday trading limits

Ability to cancel tickets after day-end (in certain cases)

Approver/Authorizer limits


 

Brokerage authorization control

  

Audit trail to track and display limits positions

  

Ability for temporary enhancement of limits

Middle office analytics
(Alchemy Risk Manager required)

  

VAR – Value at Risk reports

  

Incremental VAR

  

Duration and Convexity

  

Instrument pricing calculators

  

 

FX Back Office

Daily Processes

Tickets settlement

Day Start for Forex Market

Access to FX Tickets

FC Asset/liabilities balances

Deal Verification

Deal Confirmations

Deal Authorization

Ticket Prints for all deal types

SGL Prints for certain deal types

Ability to upload Price Feeds for Forex Market (Reval Rates)

Ticket Prints for all deal types

Ability to mark status of confirmations received from counter parties

OMO/Discounting Documents’ Prints

Forex Market Accounting for all deal types

Discounting Annexure

Day End for Forex Market

SWIFT Message (MT 320)

Day End Accounting for Forex Market

Integration with Core banking

SWIFT Messages (MT 202,300,210)

  

Workflow

Accounting Module (GL)

Four Eye principal input and control for tickets

Automated Voucher Generation

Ticket return, append ability

Daily maturity accounting

Tickets approval limits

Fully detailed FX Accounting for all deal types

Ability to cancel tickets before authorization

Day Start/End Accounting

Ability to cancel tickets after authorization

Audit Trail for Activity

Ability to cancel tickets after day-end (in certain cases)

Export of SoC (accounts) reports
 

Brokerage Accounting Manual voucher entry for GL

 

 

Equity Front and Middle Office

Tickets

Information Screens

Equity Ready

Equity Blotter
 

Trading Portfolio
 

Investment Portfolio
 

Bonus Shares Portfolio
 

Top 50 Analytics
 

EQ Breach Limits Indication

Workflow

Limits Engine

Four Eye principal input and control for tickets

Ability to Stop ticket on potential limit breach

Ticket return, append ability.

Current Limit Status Screen

Tickets approval limits

Pre trade limits check

Ability to cancel tickets before authorization

Dealer intraday trading limits

Ability to cancel tickets after authorization

Approver/Authorizer limits

Ability to cancel tickets after day-end (in certain cases)

Brokerage authorization control

Ability to change the settlement dates of authorized deals (in case of unexpected holidays)

Audit trail to track and display limits positions

  

Ability for temporary enhancement of limits

 

 

Equity Back Office

Daily Processes

Tickets settlement

Day Start for Equity Market

Access to Equity Tickets

Deal Confirmations

Deal Verification

Ticket Prints for all deal types

Deal Authorization

Ability to upload Price Feeds for Equity Market (Revaluation Rates)

Ticket Prints for all deal types

Ability to mark status of dividends received from counter parties

Integration with Core banking

Equity Market Accounting for all deal types

Automated Voucher Generation

Day End Accounting for Equity Market

Daily maturity accounting

Day End for Equity Market

Fully detailed Equity Accounting for all deal types
 

Day Start/End Accounting
 

Audit Trail for Activity

Workflow

Accounting Module (GL)

Four Eye principal input and control for tickets

Brokerage Accounting Manual voucher entry for GL

Ticket return, append ability

Manual vouchers for recording of dividends after the Ex-dividend date.

Tickets approval limits

  

Ability to cancel tickets before authorization

  

Ability to cancel tickets after authorization

  

Ability to cancel tickets after day-end (in certain cases)

  

 

Organizational setup and infrastructure

Third party integration

Notification and Alerts Module

SBP MMCRS Integrated

System wide alerts sent to relevant users on screens

SBP FXCRS Integrated

Alerts for instrument maturities, coupons

MISYS Core Banking Integrated (MM, FX, EQ Desks)

Day start/end alerts, pending ticket and voucher notifications

STAR Integrated

Notification for unconfirmed deals

SWIFT Messaging Integrated

Users Setup/Control

Custom and flexible User Roles

Role-based privileges

Page-level User security

Audit Trail for each user activity

Strong Password checks

User Lock/Unlock mechanism

User account suspension

Password expiry

User screen timeout

Single login and multiple login checks

Full Audit trail of user actions

Reuters price feeds upload integrated
 

 

Workflow

TreasuryOne has a flexible, robust 4 stage workflow in place for tickets (front, middle to back) and a 2 stage workflow for back office GL voucher entries. The workflow also works with middle office components to control limits, pre trade checks and performs user audit to monitor data input.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

UQA – Universal Query Analyzer tools

The UQA Tools enable user to query the TreasuryOne database and generate reports on their own based on various inputs, such as date, time, counterparty name, dealer id, instrument type, deal type, etc. In this way, several on demand reports can be designed, named and generated by the users themselves. The UQA tools provide an easy quick way to generate custom reports for audits, users and management requests.

LIST OF REPORTS

Money Market
  1. Realized Capital Gain / Loss
  1. Accrued Interest Summary
  1. Accrued Interest Detail
  1. Money Market Portfolio
  1. Mark to Market by Classification
  1. Maturity Gap
  1. Maturity Profile
  1. Cash Reserve Requirement Summary
  1. Money Market Daily Activity
  1. Discounting Annexure
  1. Money Market Statistics by Product
  1. Brokerage Summary
  1. Brokerage Breakup
  1. Brokerage Payment Letter
  1. PKRV Historical Rates
  1. Security Usage Trail
  1. Vouchers By Users
  1. MISYS Vouchers Reconciliation

Forex Market
  1. Foreign Exchange Position
  1. Foreign Exchange Exposure Limit (FEEL)
  1. FC Asset / Liability
  1. Interbank Gain / Loss
  1. TMU Profitability
  1. TMU Statistics
  1. Mark to Market Revaluation by Currency

  1. Maturity Gap
  1. Maturity Profile
  1. Nostro Accounts Balances by Currency
  1. Nostro Accounts Balances – Detailed
  1. Nostro Accounts Revaluation
  1. Nostro Gap
  1. Project Nostros
  1. Our / Their Nostro Balances
  1. Outstanding Deals by Currency
  1. Outstanding Deals by Type (Buy or Sell)
  1. Counterparty Limits
  1. Counterparty Exposure
  1. Limit Availability and Utilization by Counterparty
  1. Historical FEEL and NOP
  1. Historical Forex Rates
  1. Dealers Position
  1. Split Deals
  1. Yearly Volume Comparison
  1. Yearly Profit in PKR Comparison
  1. Yearly Number of Deals Comparison
  1. Yearly Brokerage Comparison
  1. Yearly Brokerage by Month
  1. Brokerage Summary
  1. Brokerage Breakup
  1. Brokerage Payment Letter
  1. Vouchers by Users

Equity Market
  1. Equity Mark to Market
  1. Capital Gain / Loss
  1. Equity Position
  1. Equity by Classification
  1. Equity Settlement
  1. Exposure Limit
  1. Daily Activity
  1. Scrip Settlement Calendar
  1. Brokerage Summary
  1. Brokerage Breakup
  1. Vouchers by Users

User Admin
  1. User Password Reset
  1. User Role Privileges Summary
  1. User Role Rights Summary
  1. User Profile

 

 


 

by ·Comments Off on The Treasury Risk workshop

Here what we covered on Saturday at the Treasury Risk crash course at the Karachi Marriot (thank you Agnes for the notes). The one day Treasury Risk workshop in Dubai is now locked in on the 18th of March 2010 at the Dusit Thani in Dubai. You can download the nomination form here for the workshop.

First, to view trends from a much broader perspective, in general the practical as opposed to the quant/ data way to view distributions (effectiveness, behaviour, relationships). This is be one with the generator function (Nassim Taleb and Fooled by Randomness) or what we call the Nirvana effect.

Second, what is really happening when model price match market prices, especially in illiquid markets such as the one year FX swap space here in Karachi, Pakistan.

Third the difference between economic capital, regulatory capital and loss capital.

Fourth, linking Value at Risk limits to Stop loss limits and linking stop loss limits to book size and risk appetite.

Fourth, the second definition of Convexity, the fact that asset prices tend to rise by more and fall by less when interest rates change and the criteria for asset liability management and hence asset selection based on convexity (convexity of assets > convexity of liabilities).

Fifth, the allocation of portfolio assets by ALM criteria (duration and convexity)

Sixth, normally distributed actual returns are a reflection that a risk manager has not added value (similar to a coin toss) and that skewness is something to be viewed favorably, provided that it is skewed in the direction that meets existing risk return philosophy.