Transcript Presentation title - Welcome to ICAI Cochin

Markets Risk: An
approach to risk
management
Satish Krishnan
Risk
Life is nothing but the
Management of Risk,
Not its elimination.
-Ralph Waldo Emerson
The Four M’s Of Risk




Monitor: Locate sources, determine frequency
review
Measure: Define each risk and quantify appropriate measures of
risk
Modify: Use financial tools to modify each risk to acceptable level
Manage: Create policies for dynamic execution of the other three
Ms
A Risk Manager wears different
hats
Businessman
Controller
Accountant
Commercial
Legal
Taxation
Risk Management : Basic Issues




Risk-Reward Relationship : There is no `low risk, high reward’ strategy.
Future is Unknown
Keynes : “Markets can be “irrational” for a lot longer than you can remain
solvent.”
Stop Loss levels must be pre-determined. Never presume the worst case is not
possible.
Choosing a RM Strategy
Customers/Suppliers
Regulators
Prevention of Crisis
Long Term Viability
Shareholders/
Analysts
Earnings Stability Upside
Potential
Lenders
Cash Flow / Credit Dilution
Company
Management
Minimise Cost of capital
Focus on Core Strengths
Rating agencies
Balance Sheet/Coverage
Types of Risk in a Corporate
CORPORATE RISKS
BUSINESS
MARKET
CREDIT
OPERATIONAL
Marketing
Foreign Exchange
Default
Controls
Sales
Interest Rate
Concentration
Systems
Competition
Liquidity
Counterparty
Data Quality
Reputation
Commodity Price
Country
Natural Disaster
Recovery
Regulatory
Product Acceptance
Quality
Paid to Take
Fraud
Paid to manage
Paid to manage
Paid to mitigate
Peter Drucker
Management by Objectives Works
if you know the
OBJECTIVES
Ninety Percent of the Time,
YOU DON’T
Important Aspects








Objectives
Risk Appetite
Risk / Hedging Policy
Yardsticks
Strategy
Risk Management Process
Control
Performance Evaluation
Market RM Process
Step 1
Step 2
Step 3
Exposure Identification
Information Flow
Management Review
Business Unit Risk profile
Activities
Type & Tenor
Magnitude
Accounting Impact
Exposure Reporting
Forecasting capabilities
Software Analysis
Awareness
Definition of objective
Decision Support
Step 4
Step 5
Policy Development
Strategy Development
Long Term Goals
Business Plan
Risk Tolerance
Centralized /Decentralized
Time horizon
Action Plan
Structural vehicles
Passive vs Dynamic
Step 7
Implementation
Intelligence
Pricing
Timing
Banks
Controls
Step 6
Hedging tools
Internal operating mechanisms
External financial instruments
Step 8
Performance Evaluation
Establish benchmarks
Monitor Strategy
Fine tune strategy
Misconceptions about Hedging

“We are conservative firm (we do not speculate) and thereby do not hedge”.

Not hedging is being aggressive, not conservative.

Both completely hedged or unhedged are extremes.

We are not in the business of currency trading.

Risk is inherent to the business

Hedging doesn’t imply speculating
Pitfalls in RM

Risk elimination or risk management

Budget ‘zero” cost for risk management

Inconsistency in approach

Responding to changes, not positioning well ahead

Getting influenced

Greed, Fear : Imbalance

Borrowing views instead of borrowing logic/analysis

Inappropriate org. structure

Poor controls

And so on…
Hedging
HEDGING
SHOULD BE CONSTRUED AS
ACTIVE MANAGEMENT
INSTEAD OF
SPECULATION
Hedging in India
Currency/Interest Rate Risk Mgmt
Regulated with enough headroom
 Underlying exposure requirement

Third currency participation
 Past performance route – limited
flexibility

Very active forwards and swap market
 Conventional and most popular
 Liquid vanilla option markets

Options
Vanilla
Barrier
Digital
Ratchet
Other exotics
Swaps
Cross Currency swaps
Principal Only swaps
Interest Rate Swaps
fltg-fxd, fxd-fltg, basis
Commodity Risk Management

Conventional approach



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

Deregulations on derivatives
Underlying exposure requirement
Hedges are cash settled
Approval process




Inventory scaling
Proxy hedging
Listed/non-listed
OTC / Exchange traded contracts
Special account for settlements
Reporting to RBI
Precious Metals
Base metals
Energy
Softs
Agri
Others Risks

Liquidity




ALM
Swaps
Arbitrage deals – impact on liquidity risk
Credit



Impact: Pricing, Solvency
Credit insurance
Bank facilities
–
–

Letters of credit
Without recourse bill discounting
Credit Derivative Swaps
Global Meltdown - a brief discussion

Global Outlook: The going gets tougher.

India: Insulated but not immune.

Positive secular outlook remains intact
September 2007: a month to remember
Source: Internet
September 2008:The fear haunts again
Source: Internet
Clash of titans
Measures announced by the US
Measures announced by the UK
 TARP (USD 700bn)
 Recapitalization plan worth GBP 50bn
 USD250bn bank bail out
 Special Liquidity Scheme worth GBP 200bn
 Support to Commercial Paper
Liquidity injection
 Wholesale funding support on new short – medium
term issuance by the banks worth GBP 250bn.
Rate cuts
 Rate cuts
Measures announced by the EU
Measures announced by the EMs
•Rate cuts.
•Guarantee bank debt (FR: Euro 320bn, SP 100bn)
•Provide interbank lending( GR: Euro 400bn)
•Recapitalisation of banks ( GR:80bn, FR: Euro
40bn,SP: Euro 50bn)
•Total plan worth Euro 1812bn ( UK included)
•Interest rate cuts
•Liquidity Injection
US Real Economy: The “uhs” and “ohs” to
continue
Job market jolts
Housing sector: Searching for the bottom
400
275
300
300
200
325
350
100
375
0
1,600
11
1,400
10
9
1,200
8
1,000
7
400
-100
425
-200
450
-300
475
-400
500
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Change in non-farm payrolls
6
800
5
600
4
400
3
Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-08 Jan-08 Jan-08 Jan-08
New home sales
Initial jobless claims (RHS, inverted)
Source: US Labor Dept., SCB Global Research
Source: NAR, SCB Global Research
Credit availability tightens
And confidence crumbles
9.0
8.5
165
8.0
145
7.5
Months supply of unsold new homes (RHS)
125
7.0
105
6.5
85
6.0
65
5.5
45
5.0
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Conforming mortgage rate
Jumbo mortgage
25
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
Conference Board
Sources:Banxquote, SCB Global Research
U. of Michigan
Sources: Conference Board, U. of Michigan
Recession DEFINETLY underway now:
GDP growth QoQ SAAR
%
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
Mar-00
Sep-08
Mar-08
Sep-08
Mar-08
Sep-08
Mar-08
Quarterly data, last data point: Q2-08, Forecasts in red
Sources: Bloomberg, SCB Global Research
Let’s have no illusion!
The bail put plan
Source: BBC website
Euro zone: A deteriorating outlook
Inflation: On a steady decline

The outlook for the Eurozone’s
economy has deteriorated
substantially

We now expect the current recession
to continue well into 2009, with
contracting GDP in Q408 and in the
first half of 2009, and GDP falling by
-1.0% overall in 2009

Inflation has been steadily declining
since July on the back of the massive
drop in oil prices. Latest figures
showed inflation easing to 3.2% y/y in
October from 3.6% prior.

Although this is still way above the
ECB’s target rate it is likely to fall
further in coming months, allowing
the ECB a free hand to cut rates
further.

The refinance rate is expected to fall
to 1% by end of 2009 from the current
2.5%.
Tougher times ahead for the Eurozone
Source: Bloomberg, SCB Global Research
UK: Already in the league
House prices continue to fall y/y %
House Price s Continue to Fall

Housing market slump deepening. House
prices decelerate by -12.4% in September.
Mortgage approvals were down 75% from
their peak.

High inflation, tighter credit conditions
hitting consumer confidence hard.

Manufacturing, construction ,services
sectors are sliding deeper into contraction
territory.

Inflation expected to head lower towards
the 1-3% target band from Q209 onwards.

We expect GDP to contract by -2.3% in
2009 and see growth of only +0.6% in 2010

UK rates now likely to fall to 0.5% by end
2009 from the current 2%.
15
10
%
5
0
-5
-10
Nationwide House Prices y/y
Sep-08
Jun-08
Mar-08
Dec-07
Sep-07
Jun-07
Sep-06
Dec-06
Mar-07
-15
HBOS House Prices
Sources: Bloomberg
Dipping Confidence
GFK Consumer Confidence
10
5
0
-5
-10
-15
-20
-25
-30
-35
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
Mar-02
Sep-01
Mar-01
-45
Sep-00
-40
Sources: Bloomberg
Source: Bloomberg, SCB Global Research
Forecasts
Q3 08
Q4 08
Q1 09
Q2 09
2008
2009
GDP q/q SAAR
-0.5
-4.0
-4.0
-3.0
1.3
-2.0
Core PCE deflator
2.40
2.00
1.60
1.20
2.30
1.00
FFTR
2.00
0.50
0.50
0.50
0.50
0.50
GDP y/y
0.50
-0.60
-1.80
-1.50
0.90
-1.00
Inflation
3.80
3.00
2.50
1.50
3.50
1.50
Refi rate
4.25
2.50
1.50
1.00
2.50
1.00
EUR/USD
1.41
1.24
1.20
1.22
1.24
1.30
GDP y/y
0.40
-1.40
-2.40
-2.90
0.70
-2.30
Inflation
4.80
4.00
3.20
2.00
3.90
1.60
Base rate
5.00
2.00
0.50
0.50
2.00
0.50
GBP/USD
1.78
1.43
1.38
1.42
1.43
1.55
GDP y/y
0.10
-0.70
-0.70
-1.50
0.40
-0.70
Inflation
2.20
2.00
2.00
1.50
1.60
1.40
O/N rate
0.50
0.30
0.30
0.30
0.30
0.30
USD/JPY
106.11
95
94
102
95
115
USD
EURO
UK
JPY
What about India?
Insulation: Strong domestic orientation
Contribution to GDP growth from PCE and
investment
Asian economies’ export exposure vs. domestic momentum
100%
90%
VN
IN
80%
MY
CH
HK
SK
70%
60%
PH
SG
ID
50%
40%
TH
TW
30%
20%
10%
0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
Exports to the US as % of GDP, 2006/7*
* Includes indirect exports to the US, assume half of exports to China are for processing and re-exports
Sources: CEIC, SCB Global Research
But not immune :Market linkages remains strong
FII monthly inflows ( LHS USD bn)
6
INR
50
4
46
2
42
0
Mar-06 May-06 Jul-06
Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07
Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08
Sep-08
38
-2
34
-4
-6
30
Sources: SEBI, Reuters
Capital account story
INDIA'S BALANCE OF PAYMENT POSITION
2006-07
2007-08
Apr-Jun
2007
Apr-Jun
2008
Current Account
(9.8)
(17.4)
-
(6.3)
(10.7)
Capital Account
45.8
108.0
-
17.3
13.2
0.6
1.5
-
0.2
(0.3)
36.6
92.2
11.2
2.2
Errors & Ommissions
Overall BOP
Sources :RBI
Balance of Payment- Break up
BREAK UP
2006-07
Current Account
Merchandise
Services
Transfers
Income
Capital Account
Foreign Direct Invt
Foreign Portfolio invt
Loans
Banking Capital
Others
2007-08
Apr-Jun
2007
Apr-Jun
2008
(63)
32
28
(7)
(9.8)
(90)
38
41
(6)
(17.4)
(20.7)
8.7
7.5
(1.8)
(6.3)
(31.6)
10.5
11.5
(1.1)
(10.7)
8.48
7.06
24.53
1.91
3.79
45.8
15.55
29.26
41.96
11.75
9.5
108.0
2.7
7.5
9.0
(0.9)
(0.9)
17.4
10.1
(4.2)
4.1
2.7
0.5
13.2
Sources :RBI
Growth Interrupted
A year to moderate
Real GDP growth
But not a mirror image
Forecast
9.00
7.00
5.00
FY 03 FY 04 FY 05
FY06
FY 07 FY 08 FY 09
Source: CSO, SCB Global Research
INR forecasts
Q4 2008
Q1 2009
Q2 2009
Q3 2009
FY 08-09
FY 09-10
GDP (%)
y/y
7.40
7.20
7.10
8.0
7.4
8.5
Inflation
(%)
12.18
12.35
9.82
6.31
10.87
3.60
Repo rate
9.00
9.00
9.00
9.00
9.00
9.00
INR
48.50
49.50
48.30
47.00
49.50
45.00
Source: SCB Global Research
Be cautious but don’t be pessimist!
And the big picture
Favourable demographic structure:2025
0-4
4-15
15-60
Higher savings and investment rates (%)
>60
Savings Rate
0.4
100%
90%
0.35
80%
0.3
70%
Investment rate
0.25
60%
0.2
50%
%
40%
30%
0.15
0.1
20%
10%
0.05
0%
0
JP SG HK SK VM CN TB MY ID IN PH
FY 00
FY 02
FY 04
FY 06 (P)
Sources: RBI, SCB Research
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