Risk Monitoring And Assessing Large Exposures – A Stradivarius Will Deliver World Class Performance

By Yang Zhang, Product Manager – Global Liquidity and Capital Risk and Mahim Mehra, Senior Risk Advisor, AxiomSL

The European Banking Authority (EBA) recently updated large exposures rules defining calculation methodologies and reporting requirements as part of Capital Requirements Regulation (CRR2) reforms. The requirements for assessing large exposures are coming into force in 2021 for European Union firms and are expected to come into force in 2022 in the United Kingdom. These updates and impending CRR3 reforms require that firms consider new scope of data under large exposures in addition to new calculation methodologies and treatments that will impact exposure limits to counterparties or groups of counterparties.

The aforementioned changes will require institutions to have a holistic Basel risk management framework with robust large exposures capabilities, so they are enabled to closely monitor their counterparties and keep up with the latest regulator prescribed rules and methodologies. As organizations take on board Basel IV and CRR changes to large exposures guidelines, they face challenges such as:

  • Adapting to new rules – including recognizing exposures to underlying issuers for banking book derivatives
  • Implementing changes to calculation methodologies – including accounting for exposure to collateral issuers where collateral has been used to reduce an exposure
  • Bringing in and managing additional data elements and data relationships needed to facilitate the rules – including CRR3 and those mentioned above

Determining Risk Appetite And A Strad’s Capabilities

The new calculation methodology may further limit the amount of risk firms are able to take on. Thus, it is necessary for them to accurately assess the type and concentrations of their exposures – both for internal risk monitoring and for meeting regulatory imperatives.

A finely crafted Stradivarius violin is a masterpiece, but regardless of how well it is put together, it only remains in fine form if it is played regularly. Similarly, firms need to continuously ensure that their exposures are in line with their risk appetite by “fiddling” with their portfolios and monitoring changes.

Violins And Large Exposures Calculation Complexities Require Regular ‘Tuning’  

The complexity of assessing large exposures involves calculating the components to be included – such as credit risk under standardized approach to counterparty credit risk (SA-CCR) and other upstream risk factors like fundamental review of the trading book (FRTB). FRTB will need to be included when assessing large exposures once it becomes applicable for market risk calculations under CRR3. Furthermore, all risk factors must be viewed in context because where the world is going should determine where appetite for the ensuing risk is going.

Since even the most gifted musician needs to practice their instrument every day, top violinists never go a day without tuning their instruments and honing their skills. Having a full risk picture requires a similar sort of monitoring and re-tuning. For example, today a firm might look at a group of counterparties comprising their top ten to determine their capital and risk management strategies. However, when CRR2 is applied, in a couple of short months the same group could be very different and there may be breaches of limits that require adjustments to exposures to remain compliant. Thus, continuously monitoring and assessing large exposures across a changing operational and regulatory landscape is critical. Furthermore, to ensure efficient capital management responses an organization must have quick access to accurate insights.

A Complete Risk Picture Means Considering All The Pieces…

While the fundamentals of building a violin are simple: spruce and maple wood are carved out and pieced together then strings are added later, creating an instrument of world-class quality requires a highly skilled hand. A complete risk picture requires similar finesse: how can credit risk, market risk, and assessing large exposures be accurately and cohesively brought together into a single risk management picture?

There are a few factors that affect how institutions are assessing large exposures to both meet regulatory imperatives and enable effective risk monitoring. Under CRR2 more firms will need to report as they are expected to fall into the category of being subject to large exposures that go above regulatory limits. Additionally, since SA-CCR must now be used to assess exposures, calculation changes could result in more exposure than an organization had previously. If firms are over prescribed limits in the European Union or need to remain under certain limits to be Basel IV compliant in other regions, firms will need to either lower their risk profiles or maintain greater capital amounts in response to their assessment of large exposures and corresponding capital charges.

…And The Devil Is In The Details

Another layer to this reporting burden is counterparty exposures reporting resulting from traceable counterparty interlinkages. With new granular reporting mandates, each exposure is recorded with a unique LEI identifier – enabling the EBA to cross validate between firms’ submitted reports. If one institution has not reported their complete exposure to a given counterparty, it will not escape the EBA’s notice. Without an ability to accurately assess counterparty linkages and aggregate exposures, efficient and confident compliance becomes extremely challenging.

It All Adds Up To A Beautiful Performance

Having an eye for detail is a big advantage for violin luthiers as they build instruments intended to create beautiful performances in a concert hall. Similarly, having comprehensive, transparent, high-quality data on hand is equally advantageous for financial institutions when assessing their exposures and risk appetite. In the 17th century, the Stradivarius family of Cremona became famous the world over for building extraordinary violins because details that went into each instrument were minute and exacting. But creating a beautiful performance in today’s concert halls is the sum of those details that, when integrated, lead to a holistic and inspiring performance appreciated both by the audience and the violinist.

AxiomSL Provides An Ecosystem That Tunefully Addresses Large Exposures And Risk Monitoring

 Institutions also require a holistic perspective like that of a world-class violin performance when assessing large exposures and gleaning risk insights across their organizations. They require processes that allow them to efficiently and consistently aggregate and monitor data at a high level, while also being enabled to drilldown into calculation details.

As depicted below, AxiomSL’s capital risk management ecosystem runs on the ControllerView® platform, which seamlessly ingests source data from wherever it exists in the organization without the need for transformation into another system. Clients can consolidate this data via the CapitalView data dictionary and region-specific extensions, which provide consistent, traceable data to the ecosystem’s solution components, including the large exposures module.

AxiomSL’s Capital Risk Management Ecosystem

While third party solutions are often black box and do not provide interlinkages across an organization, AxiomSL’s large exposures module running on the ControllerView data management, analytics, and reporting platform is part of a comprehensive capital ecosystem, enabling firms to:

  • Accurately monitor risk appetite and limits across industries, asset classes, and counterparties
  • Ensure that counterparty linkages are accurate and transparent
  • Track exposures with daily, monthly, and quarterly monitoring
  • Proactively report and remediate exposure thresholds within tight timelines
  • Trust calculations corroborated against ‘golden source’ International Swaps and Derivatives Association (ISDA) guidance for FRTB, SA-CCR, and CVA

In addition, AxiomSL’s comprehensive risk management and reporting ecosystem – spanning large exposures, market risk (including FRTB) and counterparty risk – uniquely enables clients with a consistent, traceable, and attestable end-to-end workflow for the interrelated risk positions that firms must manage.

Futureproofing: Enabling The Instrument To Sound Its Best  

AxiomSL’s automated cloud and SaaS-enabled large exposures solution and capital-risk ecosystem are built on deep industry knowledge and experience of working closely with banks. Clients are enabled to respond nimbly to change, paving the way for them to futureproof their risk management and reporting capabilities. Risk management teams and senior stakeholders gain both high-level and granular views of their organizations’ capital/credit/liquidity risk positions, as well as powerful operational flexibility. All of this enables them to put processes in place to meet regulatory imperatives, manage ongoing changes, and gain a comprehensive perspective of both near and long-term risk.

If it is well played and tuned with an eye for detail, a superlative instrument, like a violin from Cremona, possesses all the qualities needed to deliver a top-level performance – both today, tomorrow, and well into the future.

For a Stradivarius-like approach to risk monitoring and assessing large exposures,  contact us.

We invite you to read other topical pieces on Basel IV and CRR2:

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