ABN AMRO Futures Ltd
Counterparty Due Diligence
Craig MacDougall
Head of Credit
ABN AMRO Futures Ltd. London
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ABN AMRO Futures Ltd
Subject Matter
Due Diligence
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Why?
How?
How Far Do We Go?
What Questions To Ask?
Where to Look For Possible Problems?
How To Keep Up-To-Date
When To Review
Trends and Information Sources
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ABN AMRO Futures Ltd
'Don’t try to teach your grandma to suck eggs!'
Definition: • Charles Earle Funk says in “Hog on Ice” (Harper & Row, New
York, 1948). “To teach one’s grandmother to suck eggs – To
offer needless assistance; to waste one’s efforts upon futile
matters; especially, to offer advice to an expert. This particular
expression is well over two hundred years old; it is just a
variation of an older theme that was absurd enough to appeal to
the popular fancy. One of the earliest of these is given in Udall’s
translation of ‘Apophthegmes (1542) from the works of Erasmus.
It reads: ‘A swyne to teach Minerua, was a prouerbe, for which
we sai: Englyshe to teach our dame to spyne.’” That last bit was
about an expression, don’t try to teach a dame to spin.
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ABN AMRO Futures Ltd
COUNTERPARTY
DUE DILIGENCE
WHY?
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ABN AMRO Futures Ltd
COUNTERPARTY DUE DILIGENCE - WHY?
ANSWER:SCANDAL =
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ABN AMRO Futures Ltd
COUNTERPARTY DUE DILIGENCE - WHY?
Or even
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ABN AMRO Futures Ltd
COUNTERPARTY DUE DILIGENCE - WHY?
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ABN AMRO Futures Ltd
COUNTERPARTY DUE DILIGENCE - WHY?
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ABN AMRO Futures Ltd
COUNTERPARTY DUE DILIGENCE - WHY?
In many ‘loss given default’
situations, lack of effective due
diligence can be a significant factor.
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ABN AMRO Futures Ltd
How to KYC
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Client Visits.
Financial Reports and Accounts.
Compliance, Legal Checks and MLRs.
Market Knowledge and Developments.
Stock price performance (KMV etc).
The WEB.
Regular Reviews.
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ABN AMRO Futures Ltd
How Far Should Due Diligence Go?
A. “As far as necessary to be comfortable!”
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ABN AMRO Futures Ltd
What are the vital questions?
A. Clearly this is dependent on the type
of risk and the type of client...
• Do you know your customer?
• Does their business make sense?
• Can they support the risk?
• Is the legal documentation enforceable?
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ABN AMRO Futures Ltd
Client Visits (what to consider)
• Make real use of a client visit. Don’t just
sit in the CFO’s office!
• Walk through systems.
• Speak to staff.
• Inspect & ask for copies of other bank
or broker facility documentation or get a
letter of confirmation... don’t allow your
firm to be ‘Dutch-auctioned’.
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ABN AMRO Futures Ltd
Client Visits (what to consider)
• Try to gain a good understanding of the
client’s business.
• Do you feel that senior management are
effecting good control?
• Discuss their risk management
processes?
• How do they control Operational Risk?
• Do they have a DR Site? - really?
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ABN AMRO Futures Ltd
Client Visits (what to consider)
• Which VaR or DEaR method is used historical simulation, parametric or
Monte Carlo?
• Are the input variables sensible confidence level, holding period,
volatility, correlation, forward pricing?
• Are abnormal/tail event risks catered
for?
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ABN AMRO Futures Ltd
Client Visits (what to consider)
• Are any other portfolio risk management
methods used and do they make
sense?
• Do risk controls extend to limits by
region, product, tenor and basis?
• What stress testing is performed?
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ABN AMRO Futures Ltd
What Can Be Learned From Recent Events?
• Like price volatility, ratings downgrades
can trigger huge calls…
• In the Californian power crisis last year
some firms had margin calls of
US$900mn in a single day, even when
fully hedged!
• ...so how much risk capital and liquidity
resources does the counterparty have?
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ABN AMRO Futures Ltd
Financial Reports and Accounts
• Analyse the financial position
thoroughly. Request clarification of
unusual items or notes. Look out for
‘dodgy deals’ e.g. round trip trades or
granting options to raise premiums.
• Get bank and third party references if
necessary.
• Get a feel for the management. What
does your instinct tell you?
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ABN AMRO Futures Ltd
Financial Reports and Accounts
• FAS133; FAS141 & 142 re derivatives;
goodwill, other intangibles and business
combinations…
• ...serious impact on firms income and
equity base for impairment or trading
assets may be overstated.
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ABN AMRO Futures Ltd
What are the Compliance & Regulatory
Implications?
A: Management has the responsibility to
effect proper control over its business.
This means complying with regulatory
requirements, company compliance
rules and internal controls.
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ABN AMRO Futures Ltd
Market Knowledge and Developments
• Make contact with counterparts at other
firms, not just at home but overseas too.
Risk groups such as PRMIA and FOA
are an ideal way to do this.
• Have a good channel of communication
with traders.
• Get access to as many information
sources as possible.
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ABN AMRO Futures Ltd
How often should you review?
A. Regularly... Ideally shortly after
inception and then at regular intervals,
at least annually. Again, may vary.
• Ensure accounts come through on time.
• Ensure covenants are met.
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ABN AMRO Futures Ltd
Future Trends?
• Credit due diligence is deepening and
widening in scope in order for the bank
or broker to know its customer.
• Some customers have prepared highly
detailed information packs on relevant
areas of their internal control processes.
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ABN AMRO Futures Ltd
Where can third party information be
obtained from?
A. There are some very useful providers
of free information and many that
charge for their services. See the
attached non-exhaustive list.
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ABN AMRO Futures Ltd
Third Party Information Websites
Moody’s
www.moodysresearch.com/
Standard & Poor’s
www.ratingsdirect.com/
FitchIbca
www.fitchibca.com/
Wright Investor Services
profiles.wisi.com/
Banker’s Almanac
www.bankersalmanac.com/
Financial Times
markets.ft.com/news/markets
Blomberg
www.bloomberg.com
Reuters Business Brieffing
www.rbb.reuters.com/
Wall Street Journal
online.wsj.com/public/us
Bankscope
Dun & Bradstreet
Amadeus
Citywire
www.citywire.co.uk
efinancialnews
www.efinancialnews.com/
Italian Fund Management Data
www.assogestioni.it
Companies House
www.companies-house.gov.uk/
Financial Services Authority
www.fsa.gov.uk
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