Forum on Asset Liability Management
Gautam Mitra
Forum on Asset Liability Management
• Background and overview of Asset and Liability
Management
• Asset and Liability Management applied to Banks
• Asset and Liability Management applied to Insurance
Companies
• Asset and Liability Management applied to Pension Funds
• Asset and Liability Management: Other application areas
• Industry insights, technology, products and services
• Directory of Asset Liability Management Solution and
Service Providers
• Bibliography
Forum on Asset Liability Management
Con Keating
Asset and Liability Management
Some Issues
It is impossible to achieve demonstrably true knowledge about
our universe or ourselves.
Nor is logic decisive. No kind of reasoning can ever give rise
to a new idea.
Hume
London November 2009
Con Keating
5
Liability Driven Investment
The PPF
• The PPF reported investment returns for 2008/9 of 13.4% including
swaps versus a target of 6.2%
• Ex swaps the return was -3.4%
• Long dated gilts moved just 3 basis points in this year
• But swaps versus gilts (25 year) compressed by 61 basis points
• This is a return equivalent of 14.5%
• This is the principal source of the swap performance.
• Swaps were trading 45 basis points through gilts
• Having been 100 basis points through earlier in the crisis
• It is a staggering basis risk for the ALM position.
• Why does the PPF own swaps which yield less than gilts?
Hedging
• A UK corporate borrowed £100 million as a 12 year floating rate
note paying 5/8% over interbank offered two years ago.
• They swapped this for fixed paying 5.5%
• They entered a credit support agreement for the swap, under which
cash collateral could be called.
• Swap rates declined to 4.00%
• They were called for collateral of £12.2 million
• This was cash they did not have and were forced to borrow from
their bank on adverse terms
• The cost of the financing has risen dramatically
• The effective term of the financing has shortened
• The basis risk is enormous
The individual
• Only 20% of personal wealth takes the form of financial assets and
property.
• 80% is human capital to be consumed and converted to other wealth
over the future life time.
• Many other institutions share this property of future income
• Pension schemes are one example
• The status quo is simply an accrued endowment - the present value
of future contributions can dominate this entirely.
A pension scheme
• Once future contributions are considered
• The optimisation problem is no longer maximisation of current asset
values at either short or long horizons
• The new contributions can be thought of as consuming investments
• And for those we want the price of investments to remain low
• The ALM problem is dramatically different
• Think about a coupon bond when prices decline and yields rise
• The realised total return increases due to the higher reinvestment
rates
• We no longer want high market (beta) returns since these hurt our
new money contributions
• But we do want returns which are independent of the market
• And that is the case for Alpha
BrightonRock Policy
•
•
•
•
•
Institutionalises this insight contractually
It stabilises the current value of the portfolio
By removing short term concerns
Allowing long term investment
And lowering scheme financing costs
Forum on Asset Liability Management
Michael Dempster
Forum on Asset Liability Management
Elena Medova
Forum on Asset Liability Management
Moorad Choudhry
Bank Liquidity Risk Management: Reporting and Metrics
Asset Liability Management Forum
MWB, Canary Wharf
17 November 2009
Professor Moorad Choudhry
Europe Arab Bank
Agenda
• A common approach
• Five liquidity risk metrics
• Reporting considerations
Email: moorad.choudhry@eabplc.com
Please read and note the DISCLAIMER stated at the end of the presentation.
15
Introduction
• Liquidity management has emerged as the dominant element of bank asset-liability
management in the post 2007-08 crisis era
• Measuring and managing liquidity risk is an art rather than a science and should be undertaken
with prudence and a close eye to the particular bank’s own risk-reward profile and operating
model
16
A common approach…
• Management often direct Treasury and money market desk behaviour by assigning simple targets (e.g. the
Loan-to-Deposit ratio, or target deposit levels)
• Market best practice is for more than the single liquidity metric (LTD), to a broader set of measurements
and reports (to complement the LTD).
• For instance, the LTD is the best metric to measure the contribution of customer funding. The LTD,
however, is not predictive, and is blind to duration, concentration and volatility, three critical aspects of
liquidity. Finally, it is not always “aggregatable”.
• Liquidity forecasts should be upgraded to incorporate better estimates of deposits/withdrawals on the
deposit side, drawings of unused direct commitments on the loan side, and assessment of the
quality/liquidity of our near-cash assets.
• Post-Lehmans, a bank ALM crisis may arise from a negative gap situation, a withdrawal of customer
deposits or loss of interbank liquidity, among other scenarios
17
What to Look For from Liquidity Data
Self-sufficiency and supportiveness of a business unit
– Its ability to operate without support of other Group businesses
– Evidence of focus on both sides of the balance sheet
– The level to which it creates or relieves liquidity risk
– Measure of value of the business unit to the Group, in non-P&L terms
Overall level of exposure to roll risk
– Measuring asset liability mismatch
– Each liability roll is an opportunity to lose funding
Early warning of funding stress points
– Analysing the cash effects of liquidity gaps
– Examining the near term effects of the asset liability mismatch
Specific daily funding needs
– For planning & managing daily operational funding requirements
– For advanced planning of cash or collateral action
18
Metrics: Five Liquidity Reports
•
Loan-to-Deposit Ratio
•
1 Week & 1 Month Liquidity Ratios
•
Cumulative Liquidity Model
•
Inter-company Lending Report
•
Liquidity Risk Factor
These reports measure and illustrate different elements of liquidity risk:
•
•
•
•
Reports at country level, legal entity level and Group Level
Risk appetite should be determined by the ALCO or (at Group level) High ALCO
Assumptions will be reviewed by Treasury & Risk Management
Stress testing will be performed by Risk Management
19
Ways to Examine Liquidity Risk
Loan to Deposit
Ratio
1 Week & 1 Month
Liquidity Ratios
Cumulative
Liquidity Model
Intercompany
Lending Report
Liquidity Risk
Factor
Self-sufficiency of a
business unit
Supportiveness of a
business unit
Overall level of
exposure to roll risk
Early warning of
funding stress points
Specific daily
funding needs
20
Loan-to-Deposit Ratio
Characteristics
• The relationship between lending and customer deposits
• Measure of the self-sustainability of the bank (or each branch / subsidiary)
• A very common metric, usually reported monthly
Points to note
• Differentiate between stand-alone and aggregate-able LTD (depends on transferability and
currency)
• Branch / sub targets: to improve the LTD when it’s over a certain threshold (e.g. 70%), and to
maintain their LTD when it’s under that threshold
• Exceptions can be granted to certain countries in local currency (LCY) when they are below the
threshold and when the use of their excess liquidity is constrained
21
1-Week & 1-Month Liquidity Ratios
Characteristics
• Shows net cash flows, including the cash effect of liquidating “liquid” securities, as a percentage of liabilities
• An effective measure of structural liquidity, with early warning of likely stress points
• Produced weekly, one week in arrears
• Follows a Regulatory Authority limit structure for 1 Week and 1 Month ratios
• It is important to review assumptions including “stickiness” assumptions regularly
• Review Limits regularly
Country
F
D
H
G
Regional Total
1-week Gap
USD mm
1-week Liquidity
This week
Limit
-1586
188
786
550
-22.83%
15.26%
22.57%
53.27%
-62
-0.48%
-30.00%
0.00%
0.00%
25.00%
Excess
1-month Liquidity
This week Limit
-39.11%
1.62%
19.12%
69.83%
Excess
-50.00%
-5.00%
-5.00%
25.00%
-10.64%
22
Cumulative Liquidity Model
Characteristics
• Forward looking model of inflows, outflows and available liquidity
• Recognises and predicts liquidity stress points on a cash basis
• Prepared daily, at legal entity level, and Group level
• Prepared for material original currencies and at consolidated currency level
Note
• Revised assumptions on deposit stickiness, liquidity of “liquid” securities, and committed facilities will be
included here
$mm
a
b
c
a+b+c=d
e
d+e=f
g
f-g=h
1 Week
2 Weeks
1 Month
2 Month
$1,550
$10
-$10
$1,550
$250
$25
-$20
$255
-$300
$50
-$50
-$300
-$2,500
$75
-$100
-$2,525
-$3,000
$125
-$250
-$3,125
-$5,000
$350
-$1,000
-$5,650
-$6,000
$800
-$1,100
-$6,300
-$8,000
$1,000
-$1,250
-$8,250
$500
$1,000
$1,500
$2,000
$3,000
$5,000
$6,000
$7,000
$7,500
Liquidity Gap
$2,500
$2,550
$1,750
$1,700
$500
$2,000
$1,000
$1,000
-$500
Limit
$2,000
$1,500
$1,000
$1,000
$0
$0
$0
-$1,000
-$3,000
$500
$1,050
$750
$700
$500
$2,000
$1,000
$2,000
$2,500
Cumulative Net Cash Balance
Other Forecast Inflows
Other Forecast Outflows
Cumulative Cash Gap
Counterbalancing Capacity
Variance
T+1
T+2
$2,000
$0
$0
$2,000
3 Months 6 Months 12 Months
23
Intercompany Lending Report
Characteristics
• This shows the net intercompany lending
position of each branch / sub
• Measure of the self-sustainability of each
branch / sub
• Clearly displays cash contributors and cash
users
• Major KPI for Treasurers
• Produced monthly
Group Treasury
As at (date)
Total Borrowing
Total Lending
Net Intergroup Lending
London subsidiary
1,713,280
883,123
-830,157
Europe branches
-- X
-- Y
-- Z
3,345,986
17,026
453,490
978,369
195,096
83,420
-2,367,617
178,089
-370,070
0
162,000
162,000
690,949
1,516,251
825,302
Asia
NY
24
Liquidity Risk Factor
Characteristics
• Shows the aggregate size of the liquidity gap in each branch / sub
• Compares average remaining duration of assets to average tenor of liabilities
• For example,
– Average asset duration
5.00 years
– Average liability tenor 3 months = 0.25 years
– 5.00/0.25 = Liquidity Risk Factor of 20
• The higher the LRF, the larger the liquidity gap, and the greater the liquidity risk
• Tenor of liabilities will incorporate revised stickiness assumptions
• Report weekly and monthly
• Observe the trend over time and change to long-run averages
25
Sharing of Information: effective MI
Presentation of Information
• All outputs presented with a common look
• Reports designed for simplicity, with unnecessary detail removed
• Trends and limits incorporated
• Information will be shared at operating unit level, headquarters level, and at Group level
• Reports will be published initially on a shared online directory, ensuring the latest versions are
available in the same place.
26
Risk reports 1: the weekly Qualitative
• As important: the weekly qualitative report for Group Treasury (who
summarises all for High ALCO)
•
•
•
•
•
•
Content:
Explain significant changes in your 1 week and 1 month liquidity ratios
Explain any changes to your cash and liquidity gap in your Cumulative Liquidity model
Explain significant changes to the Liquidity Risk Factor
Explain growth or shrinkage of asset books
Detail any changes to intergroup borrowing/lending position; detail the counterparties for any large-size
deals
• Any increase/decrease in corporate deposits, detail large dated transactions with an estimated confidence
level of roll over
• Any increase/decrease in retail deposits
• Average daily opening cash position
27
Risk reports 2: Monthly Liquidity Snapshot
• Simply a MI summary for Group-wide dissemination
• Content:
–
–
–
–
–
The Cumulative Liquidity Report summary (cash gap and liquidity gap)
1-week and 1-month Liquidity Ratios performance against limits
Liquidity ratio current to previous month
LTD current to previous month
Net intergroup lending current to previous month
28
Four frameworks to monitor and control current and future liquidity risk...
Maturity mismatch
Purpose:
bucket.
Measure:
Analysis:
liquid
additional
determine
FX mismatch
To measure the net funding requirement (or surplus) per maturity
This is the main regulatory requirement for liquidity measurement.
Measures the net cash flow for each maturity bucket.
In the short-term, when commitments (cash outflows) exceed
assets (cash inflows) the Money Markets desk need to raise
funding. In the longer-term, structural imbalances, ALCO will
the appropriate funding strategy.
Purpose:
To measure the gap between funding and lending in each
currency.
Measure:
Funding minus lending, per currency.
Analysis:
By measuring FX mismatch, the bank gains an understanding of
its
exposure to the risk that FX swap markets become illiquid which
could
force a large open FX position or make it difficult to meet
commitments in a particular currency.
Funding
Lending
FX mismatch
Maturity Mismatch Ladder
Sight
8 Day
1 month
3 mo
6 mo
1 year
3 years
5 years
5 years+
TOTAL
Inflows
805
383
273
268
143
129
276
657
742
3,675
Outflows
980
813
838
1,563
277
52
11
0
0
4,533
Mismatch
(175)
(430)
(570) (1,295) (134)
77
265
657
742
(858)
Currency
EUR
USD
USD
GBP
Asset / liability liquidity ladder
=
GBP
USD
956
EUR
(150)
GBP
(450)
Funding concentration
Purpose:
To measure the asset liquidity and likely stickiness of liabilities.
Measure:
Each asset/liability type (per COA) is rated based on size of
holding,
contractual maturity, behavioural stickiness, yield, cost to
liquidate.
Analysis:
A detailed understanding of the attributes and behaviour of the
bank’s
balance sheet allows ALCO to make better informed strategic
choices. Liquid
Illiquid
Purpose:
Measure:
Analysis:
Custome
r
deposits
Liability
To measure the relative concentration of each funding source.
% concentration of each funding source per maturity bucket.
Analysing funding concentration risk allows the bank to develop
effective diversification strategies.
Sight – 8 days
Asset
Interbank
deposits
Group
deposits
Short-term
-
EUR
Mismatch
Long-term
1 month
Interbank
deposits
Custome
r
deposits
Group
deposits
1 year
Interbank
deposits
Custome
r
deposits
Group
deposits
29
Regulatory and Management reporting is key to successful liquidity management
Liquidity Reporting
Category
Report
Regulatory
• Consolidated basis - FSA Form LR
is the key daily report this is based
around the maturity mismatch
framework.
• Daily Liquidity Report
Prepared by: Finance Regulatory
Reporting Team
Branch liquidity
Measure
s
Audience / Frequency
Maturity mismatch
• Sight – 8 days > 0.00%
• Sight – 1 month > -5.00%
• DLR = Daily to management
• Form LR = Monthly to FSA
• Copy of monthly reports send to
each host regulator (tbc)
Five Liquidity Metrics
• Monthly to management
Leading and lagging risk indicators to
provide a 360° view of the bank’s
liquidity.
• Maturity mismatch framework
Maturity transformation
• Average asset tenor < 24x average
liability tenor
• Daily to Finance + Treasury
• Monthly to management
Prepared by: Finance Regulatory
Reporting Team
Management Reporting
Prepared by: Finance
Management Information Team
• FX mismatch
• Asset / Liability liquidity ladder
• Funding concentration
Funding source concentration limits
• No individual counterparty > 5% of
funding
• No source > 25% (except customer
deposits)
• Customer deposits > 33% of funding
FX mismatch limit
• No mismatch > 25% of currency
volume (G7)
• No mismatch > €10mn for non-G7
currencies
Minimum cash buffer
• Cash buffer > 2% of liabilities at all
times
30
Bibliography
• Choudhry, M., et al, Capital Market Instruments: Analysis and Valuation, 3rd edition, Basingstoke: Palgrave
MacMillan
• Choudhry, M., Bank Asset and Liability Management, Singapore: John Wiley & Sons 2007
• Choudhry, M., The Money Markets Handbook, Singapore: John Wiley & Sons 2004
31
DISCLAIMER
The material in this presentation is based on information that we consider reliable, but we do not warrant that it
is accurate or complete, and it should not be relied on as such. Opinions expressed are current opinions only.
We are not soliciting any action based upon this material. Neither the author, his employers, any operating arm
of his employers nor any affiliated body can be held liable or responsible for any outcomes resulting from
actions arising as a result of delivering this presentation. This presentation does not constitute investment
advice nor should it be considered as such.
The views expressed in this presentation represent those of Moorad Choudhry in his individual private capacity
and should not be taken to be the views of Europe Arab Bank or Arab Bank Group, any affiliated body,
including London Metropolitan University and YieldCurve.com, or of Moorad Choudhry as an employee of
Europe Arab Bank or representative of affiliated body. Either he or his employers may or may not hold, or have
recently held, a position in any security identified in this document.
This presentation is © Moorad Choudhry 2009. No part of this presentation may be copied, reproduced,
distributed or stored in any form including electronically without express written permission in advance from the
author.
32
Forum on Asset Liability Management
Stuart Jarvis
Private and confidential. Not for public distribution. Professional investors only.
Asset Liability Management
Forum event
ALM for pension plans
Stuart Jarvis
Director of research, Client Solutions
17 November 2009
34
Summary
• Funding challenges for UK pension plans
• Constructing asset liability solutions for pension plans
• Asset liability management in practice
35
Private and confidential. Not for public distribution. Professional investors only.
Funding challenge
• Since a peak in mid 2007, funding positions have worsened considerably
PPF 7800 Index
• UK plans have historically taken
150
a lot of risk
Surplus/Deficit (£bn)
100
• Now widely accepted that strategies
need to be more liability-led and
dynamic
50
0
-50
-100
-150
-200
-250
Jul-09
Mar-09
Nov-08
Jul-08
Mar-08
Nov-07
Jul-07
Mar-07
Nov-06
Jul-06
Mar-06
Nov-05
Jul-05
Mar-05
Nov-04
Jul-04
Mar-04
Nov-03
Jul-03
Mar-03
-300
Source: Pension Protection Fund
36
Private and confidential. Not for public distribution. Professional investors only.
Evolution of investment strategy
Static perspective: spend risk budget as efficiently as possible
Typical current investment policy
Possible intermediate solution
‘Ideal’ future investment policy
Liability hedge
Liability hedge
Bonds
Equity β
and
constrained α
Diversified α
Bond α
Diversified β
and α
Diversified β
 Simple
 Hedge unrewarded risks
 Hedge unrewarded risks
 Unrewarded risks
 Diversify risk budget
 Diversified beta
unhedged
 Constraints inhibit
performance
 Constrained ability to
 Diversified alpha
820239
grasp opportunities
37
Private and confidential. Not for public distribution. Professional investors only.
Eyes on the prize
Dynamic perspective: risk is being taken in order to bring assets into balance with liabilities
110%
New target path
100%
Realised performance
90%
80%
70%
Initial target path
60%
Start
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8 Year 9 Year 10
If realised returns above target, can afford to target lower return
(And if returns below target, may need to target higher return)
38
Private and confidential. Not for public distribution. Professional investors only.
Dynamic portfolio allocation process
As the return target changes, so must the portfolio allocation
Private Equity
Dynamic rather
than static
portfolio
Equity
Emerging Market Equity
Return
Property
Infrastructure
Emerging Market Debt
Gilts
& Swaps
High Yield Bonds
Corporate Bonds
Risk
39
Private and confidential. Not for public distribution. Professional investors only.
Commodities
Cumulative impact of dynamic asset allocation policy
Distribution of outcomes no longer so wide; significant downside benefit
Frequency
Funding level with dynamic weights
160
140
120
100
80
60
60%
70%
80%
90%
100%
110%
120%
130%
140%
Funding level
Fixed weight
40
Dynamic weights
Private and confidential. Not for public distribution. Professional investors only.
60
80
100
120
140
Funding level with static allocation weights
160
Practical considerations
41
Private and confidential. Not for public distribution. Professional investors only.
Adding a floor
Minimum as well as target funding level
Strategy outcomes
120%
110%
Funding level
100%
90%
80%
70%
60%
50%
Cumulative growth asset return
Target
42
Funding target
Static weights
Private and confidential. Not for public distribution. Professional investors only.
Funding target + floor
Contributions
This is not just an investment problem
Sponsor
covenant
Investment
policy
43
Private and confidential. Not for public distribution. Professional investors only.
Contributions
Putting it all together
Monitoring and action
• Overall framework is best set in advance
• Clear goal
• Create framework for appropriate real-time engagement
• Delegation
• Market opportunities
• Beyond capital allocation
• Some assets easier to move than others -> use derivatives
• Monitoring and reporting framework crucial
• Aggregation
44
Private and confidential. Not for public distribution. Professional investors only.
Conclusions
• Pension plans changing their focus from static weights to fixed target
• Dynamic strategies to support this are intuitive
• Complex dynamics
45
Private and confidential. Not for public distribution. Professional investors only.
Forum on Asset Liability Management
Marcus Hurd
Pensions – Asset Liability Modelling
Traditional
deterministic
Simple Stochastic
Slide 47
Pensions – Asset Liability Modelling
Investment
optimisation
Contribution
optimisation
Slide 48
Asset and Liability Management: Handbook
Contributors:
•
•
•
•
•
•
•
•
•
•
Dr. Moorad Choudhry, Europe Arab Bank
Prof. Michael Dempster, Judge Business School, Cambridge University
Dan diBartolomeo, Northfield Information Services
Con Keating, Head of Research, BrightonRock Group
Prof. Lionel Martellini et al., EDHEC Business School
Dr. Elena Medova, Judge Business School, Cambridge University
Prof. Gautam Mitra, CARISMA, Brunel University and OptiRisk Systems
Dr. H Sadhak, CEO Life Insurance Corporation, India
Dr. Katharina Schwaiger, CARISMA, Brunel University and OptiRisk
Systems
Prof. Frank Sortino, Emeritus Professor in Finance, San Francisco State
University and Director of the Pension Research Institute
Asset and Liability Management: Handbook
• Sponsorship
Opportunity
• Contact us:
info@optirisk-systems.com