Blog Week in Risk (ending Oct 16th)

David Harper CFA FRM

David Harper CFA FRM

David Harper CFA FRM
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In the forum this week (selected only because it’s been VERY busy)
Interest rates
  • It would be wrong to abandon the policy of negative rates (The alternatives are deeply unattractive, writes Kenneth Rogoff) https://www.ft.com/content/2bbc4b12-894e-11e6-8cb7-e7ada1d123b1 The comments prove the deep controversy here. For what it's worth, I believe Rogoff overestimates the role of monetary policy and under-appreciates the damage wrought by ZIRP's interference with the price-clearing mechanism (namely, asset bubbles). I added my first bank position today (BAC) as a hedge against a rate increase. Historically I have avoided bank stocks because I cannot value the equities with sufficient confidence. As a value investor, my first two rules are (i) to avoid greatly overpaying for an asset and, related, (ii) to try and avoid big drawdowns (a fancy word for losses that hurt!). History proves you win by avoiding catastrophes. How convenient that I am passionate about risk?! Therefore, I must be able to estimate the fair price. But for reasons that require an entire essay, it is very difficult to value a bank even with a CFA and an FRM. But I did today add BAC purely as a hedge against a rate increase.
  • Bernstein questions foundation of finance. Again. http://ftalphaville.ft.com/2016/10/...f-against-the-dcf-model-in-a-zero-rate-world/ “The problem is that [DCF models] were invented and historically used in a world where risk free rates averaged 5% or more. In a world where the risk free rate is close to zero then the errors in such models explode. Specifically, if the overall discount rate (WACC) falls from 10% to 5% in a very simple DCF then the proportion of the net present value accounted for by cash flows more than 5 years in the future rises from 70% to 95%. How far in the future can any analyst forecast? We would suggest that any human’s ability to forecast financial variables more than about 5 years in the future is limited at best. At the very least small errors at that forecasting horizon become very significant.”
  • Aswath Damodaran doesn’t *quite* agree with Bernstein’s bashing of DCF models under zero rates http://ftalphaville.ft.com/2016/10/...teins-bashing-of-dcf-models-under-zero-rates/ “This piece by Bernstein tells me more about how DCF is practiced (or mangled) at Bernstein than it does about DCF itself. As the piece indicates, a Bernstein DCF is a Robo DCF where as the risk free rate changes, nothing else does and not surprisingly the value goes up. In reality, the risk free rate is part of a macro economic ecosystem that is interconnected.”
  • A $7 Trillion Moment of Truth in Markets is Just Three Days Away (What will Libor do once the dust settles?) http://www.bloomberg.com/news/artic...t-of-truth-in-markets-is-just-three-days-away “The new rules require prime money market funds — an important source of short-term funding for banks and companies — to build up liquidity buffers, install redemption gates, and use floating net asset values instead of a fixed $1-per-share price … Some $1 trillion worth of assets have shifted from prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt, according to Bloomberg estimates. The exodus has driven up Libor rates as banks and other corporate entities compete to replace the lost funding. Now, analysts are debating whether the looming Oct. 14 deadline will mark a turning point for the interbank borrowing rate, as money markets acclimatize to a new reality.”
  • New Rules Transform $2.7 Trillion of Money Funds: QuickTake Q&A http://www.bloomberg.com/news/artic...orm-2-7-trillion-of-money-funds-quicktake-q-a “As of Oct. 14, the U.S. Securities and Exchange Commission is getting rid of fixed $1-a-share values for a wide swath of money-market funds. Additionally, overseers of some funds will get the ability to make it harder for clients to pull their cash in a crisis, by imposing redemption gates and liquidity fees.”
Banks
Regulatory (BIS)
  • Regulatory treatment of accounting provisions published by the Basel Committee http://www.bis.org/press/p161011.htm “In response to recommendations made by the G20 Leaders and the Basel Committee that accounting standard setters consider modifying provisioning standards to incorporate forward-looking assessments in the estimation of credit losses, both the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have finalised provisioning standards based on expected credit loss (ECL).”
  • Finalising Basel III (Introductory remarks by William Coen) http://www.bis.org/speeches/sp161012.htm “the Committee's post-crisis reforms can be grouped into three broad categories: First, the Committee is working on enhancing the risk sensitivity and robustness of standardised approaches, which facilitate the comparability of banks' capital ratios. Second, the Committee is considering additional constraints to the role of internally modelled approaches in the capital framework, particularly in areas for which the use of models may not be suitable for calculating regulatory capital. Third, the Committee is finalising the design and calibration of the leverage ratio and a potential capital floor based on standardised approaches. These measures would complement the risk-weighted capital framework and help ensure that the regulatory framework is more robust to arbitrage and erosion over time.”
  • Final standard on TLAC [total loss-absorbing capacity] holdings published by the Basel Committee http://www.bis.org/press/p161012.htm
  • The Ultimate Ebitda Fighting Championship (Sale of UFC and other buyout deals are raising concerns among regulators that banks and clients are being too liberal with adjustments to earnings to justify more borrowing for transactions) http://www.wsj.com/articles/the-ultimate-earnings-fighting-championship-1476615601 “Banking regulators have shown increasing concern about such moves in the $900 billion-a-year leveraged-loan market, in which banks lend to risky companies, often during a takeover, and then sell the debt in pieces to investors. In 2013, the Federal Reserve and Office of the Comptroller of the Currency started guiding banks to stay away from heavily leveraged deals.”
  • How Wall St. Regulation Pushed Up Libor, and Borrowing Costs http://www.nytimes.com/2016/10/15/b...tion-pushed-up-libor-and-borrowing-costs.html “As we later discovered, what Wall Street advertised as Triple-A securities were not high quality after all. When these securities lost value and had to be written down, the Reserve Fund’s cash turned out to be worth less than 100 cents on the dollar. Mr. Tarullo [Chairman of the Federal Financial Institutions Examination Council] wants to prevent that from happening again — understandably — and so has mandated that, as of Friday, money-market funds must certify that they will no longer invest in runnable liabilities, which is Fed-speak for any security that is less than 100 percent safe.”
Case Studies (Crisis)
  • Samsung Permanently Halts Production Of Galaxy Note 7 Smartphone http://www.npr.org/2016/10/11/49748...msung-halts-sales-of-galaxy-note-7-smartphone
  • Samsung Note 7 killed off after second recall https://www.ft.com/content/58d215d4-8f69-11e6-a72e-b428cb934b78 “More than $19bn was wiped off the company’s market value amid growing fears the safety issues around the Note 7 could damage the group’s reputation and have an impact on the group’s other consumer products. There have already been some signs of contagion, with a slowdown in S7 sales this week, according to one network, which cautioned that it was too early to tell if there had been sustained damage to the Samsung brand.”
  • Samsung feels heat from Note 7 fiasco https://www.ft.com/content/b5275d1c-8faf-11e6-8df8-d3778b55a923 “Samsung had initially won praise for its handling of the safety issues that plagued the Galaxy Note 7 after its launch in August … Yet that confidence was shattered when a spate of further fires caused US networks to withdraw the replacement model, with Samsung following suit this week with a total withdrawal of the Note 7 from the market. Its second recall has raised question marks over whether it had sufficiently investigated the matter in the first place.”
  • Major Investor Sues Theranos (Hedge fund accuses embattled company of a “series of lies” to attract investment of nearly $100 million) http://www.wsj.com/articles/major-investor-sues-theranos-1476139613 “The fund alleges that [Theranos] claimed their technology could do many more types of tests than it was capable of performing. Partner [the hedge fund] also alleges that Theranos overstated the scope of its submissions for Food and Drug Administration approval and its ability to meet the obligations it had agreed to in partnerships with companies like drugstore giant Walgreens Boots Alliance Inc. as it prepared to roll out its services … The hedge fund’s suit claims Theranos engaged in securities fraud, negligent misrepresentation and violations of the Delaware deceptive trade practices act, among other things”
  • Crisis of the Week: Palantir Takes Heat Over Asian Hiring http://blogs.wsj.com/riskandcomplia...ek-palantir-takes-the-heat-over-asian-hiring/ “Palantir Technologies is the subject of this week’s crisis after the data-mining company was sued by the U.S. Department of Labor for discriminating against Asian job applicants. The company, which helped the U.S. government track down Osama bin Laden, has received more than $340 million in federal contracts since 2010.”
Technology (including fintech and cyber)
  • Introducing Marcus by Goldman Sachs https://www.marcus.com/ Goldman’s new online consumer lending platform offers unsecured fixed-rate loans of up to $30,000
  • G7 sets common cyber-security guidelines for financial sector http://www.reuters.com/article/us-cyber-g-idUSKCN12B1UB The three-page document (posted by US Department of Treasury, eg) is here http://trtl.bz/2dOQ1vf
  • What to Do About Drones? Detect, Identify, Respond http://www.securitymagazine.com/articles/87507 “The new FAA projection of 30x commercial drone growth to 600,000 over the next year gives context to the size of this growing issue. These threats range from people using them as a means to spy on celebrities, interfere with fire-fighting efforts, flying over sporting events, attack the power grid and the most unsettling potential of weaponizing drones and using them as flying IEDs. Because of the danger posed by their misuse, new technology advancements mitigate potential drone threats. All of these technologies can be categorized in three categories: Detect, Identify and Respond.”
  • Connecticut Names State's First Chief Cybersecurity Risk Officer http://www.securitymagazine.com/articles/87513
  • Math Money: A simple introduction to crypto-currencies https://www.finextra.com/blogposting/13257/math-money-a-simple-introduction-to-crypto-currencies
  • 2016 RIMS Cyber Survey http://trtl.bz/rims-cyber-survey-2016 “As far as handling cyber exposure, this year’s survey saw a leap in the number of organizations who are transferring the risk. Nearly 70% reported some form of transfer, an increase of 10% over 2015. Stand-alone cyber insurance policies seem to be the preferred route: a resounding 80% of survey respondents reported purchasing this type of cover, an increase of 29% compared to the 2015 collection.”
Exams (GARP, FRM, CFA)
  • GARP updated their Continuing Professional Development (CPD) Handbook for FRMs and ERPs. Here is the 2017 Handbook http://trtl.bz/garp-cpd-2017-handbook
  • Model Risk Management under the FRTB Regime http://trtl.bz/2eoa56M “The Fundamental Review of Trading Book (FRTB) is perhaps the most sweeping, ambitious, prescriptive and demanding set of market risk regulations ever to come out of Basel. Much has been written to parse the 92-page document and its impact on banks, but what does FRTB mean for the market-risk model owners/validators who have already validated their models under the SR 11-7 framework?”
  • Also pertaining to FRTB: FRTB Market Risk Management: Planning & Executing a Strategic Plan(video blog) http://www.numerix.com/frtb-market-risk-management-planning-executing-strategic-plan
  • The Perils of Financialization (The Wells Fargo scandal is a new variation on the theme of profit-at-all-costs that pervades finance and requires a rethinking of the industry’s power, accountability and culture, says author Rana Foroohar) http://www.garp.org/#!/risk-intelligence/detail/a1Z40000003LVpUEAW/perils-of-financialization
  • Macro Risks of the US Presidential Election http://www.garp.org/#!/risk-intelligence/detail/a1Z40000003LVp0EAG
  • PRMIA’s Intelligent Risk, October 2016 http://trtl.bz/prmia-intelligent-risk-oct-2016 “This issue covers a variety of topics relating to strategic risk. Jean-Marc Schwob explores the new SACCR capital rules and their effect on corporate hedging. Brian Sentance looks at the data management challenges of FRTB and their impact on the full lifecycle of data processes. Steyn Verhoeven lays out how open banking will change the banking landscape. Patrick Toolis examines market risk cognizance in multistrategy electronic trading. Scott Warner discusses the need for risk culture to reflect differences in the geographies where it operates. Nag Deevi looks at reputational risk and the impact of negative reputation events.”
  • FRM vs CQF - Which is Better? http://www.wallstreetmojo.com/frm-vs-cqf
  • GIPS 20:20 — Vision for the Future https://blogs.cfainstitute.org/mark...-of-the-gips-standards-introducing-gips-2020/ “More than 1,600 firms worldwide have notified CFA Institute of their claim of compliance, including part or all of 23 of the 25 largest asset management firms and 74 of the 100 largest asset management firms, representing more than 60% of global assets under management.”
Financial Markets and Products (FRM P1.T3)
  • The Dying Business of Picking Stocks http://www.wsj.com/articles/the-dying-business-of-picking-stocks-1476714749 “Performance is driving the upheaval. Over the decade ended June 30, between 71% and 93% of active U.S. stock mutual funds, depending on the type, have either closed or underperformed the index funds they are trying to beat, according to Morningstar … Lawsuits also are motivating investors to make changes. Over the past decade, Jerome Schlichter, a plaintiffs’ lawyer, has been suing corporations and, more recently, colleges and universities, contending the employers breached their fiduciary duty by allowing unreasonably high fees in their 401(k)-style plans.”
  • New tool is ‘early warning’ on systemic risk http://blog.financial.thomsonreuters.com/new-tool-is-early-warning-on-systemic-risk/ Here is the white paper on their sentiment-based systemic risk (SenSR) indicator http://trtl.bz/2edre3d
Valuation and Risk Models (Including Country Risk) (FRM P1.T4)
  • Models Are Essential for Banks, but How Do We Know They’re Right? https://www.finextra.com/blogpostin...ial-for-banks-but-how-do-we-know-theyre-right “The following major elements [of managing model risk] are considered (rightly) to be necessary: Maintenance of an enterprise model inventory; and Documentation of model in an accessible repository (including Assumptions, Formulae, Data sources and uses, Business use, Independent validation, and Clear policies for model development). They are mostly self-explanatory, except that it is often not clear how to perform independent validations of models.”
  • Investors are ill equipped for our unfathomable future https://www.ft.com/content/8e5b9ac2-9126-11e6-a72e-b428cb934b78 “That leads to the third point: these distorted markets are increasingly hostage to unfathomable political risk. A decade ago, investors thought (or hoped) they could price western assets by analysing underlying economic values with spreadsheets; political risk was only something that emerging market investors worried about. Now investors holding US, Japanese or European assets need to ponder questions such as: how much further can central banks take quantitative easing? Are the US and UK governments becoming anti-business? Does the rise of Donald Trump, as well as the Britain’s vote to leave the EU, herald new protectionism? Most investors are not well equipped for an analysis of this kind. They built their careers by crunching numbers, not pondering social science. They now face an unpredictable and unfathomable world.”
  • ISO publishes powerful new tool to combat bribery http://www.iso.org/iso/home/news_index/news_archive/news.htm?refid=Ref2125
Climate (Matthew)
Books and Courses
  • Algorithms Aren’t Biased, But the People Who Write Them May Be (Mathematical models that create rankings often use proxies to stand in for things the modelers wish to measure but can’t) http://www.wsj.com/articles/algorithms-arent-biased-but-the-people-who-write-them-may-be-1476466555 “The algorithms are what Dr. O’Neil calls weapons of math destruction. WMDs, she says, share three characteristics: They are biased. They are opaque. And they are scalable.” Cathy’s book is here http://amzn.to/2dWebHg
  • Global Risk Agility and Decision Making: Organizational Resilience in the Era of Man-Made Risk http://amzn.to/2e1W0jw I started reading this. Daniel Wagner is the author of Managing Country Risk which was deleted in the 2016 FRM (but is still a good reading and one of the best introductions I’ve ever read to country risk)
SSRN
  • Cyber Risks: Emerging Risk Management Concerns for Financial Institutions https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2847191 “Addressing cyber risks may remain difficult because theorists, regulators and legislators struggle to define with specificity which acts constitute cyber threats. Similar to the difficulties that arise in financial market risk theory, defining cyber risks creates a threshold dilemma for risk management strategists.”
  • Single-Name Credit Default Swaps: A Review of the Empirical Academic Literature by Christopher Culp https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2851264 Author Culp was deleted in the 2015 FRM syllabus but he was the primary author on (P2.T6. Credit Risk) securitization concepts. His readings are still relevant, he is an excellent author, and this paper looks good.
  • Systemic Risk and Risk Management: Overview and Approach by Joseph Calandro Jr. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2851541 Here is his paper http://trtl.bz/2diAg1q
Other
 
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