Liquidity Risk Management. Baird Stephen

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СКАЧАТЬ settle transactions or make payments previously forecasted as part of the bank's liquidity pool, thereby allowing those managers to respond effectively by altering the liquidity composition and timing of payments of the bank to account for such potential losses. Credit considerations become particularly acute with respect to foreign currency exposure, as late or failed settlements from one counterparty may impact a firm's ability to obtain a currency that it must deliver to another counterparty.

      Incorporate Intraday Exposure Analysis to Size the Working Capital Reserve

      A common approach to estimating working capital begins with projecting the daily liquidity sources and uses for business operations and then augmenting these projections with stress analysis of historical end-of-day exposures. The analysis includes stressing the liquidity reserve to account for potential disruptions in projected cash flows from events such as the failure of an agent bank or financial market utility, tightening of credit provided to the firm, or an increase in failed trades and delayed settlements.

      While this approach highlights scenarios of potential liquidity disruptions during periods of market stress, it may not appropriately estimate the magnitude of these events. A firm's intraday liquidity needs could be significantly higher than its historical end-of-day exposure may indicate. Leading firms have now started to estimate their working capital needs using intraday exposures to account for these large spikes in business activity and the resulting liquidity needs throughout the business day that may not otherwise be reflected in end-of-day metrics.

      The Convergence of Collateral and Liquidity

      Invest in Collateral Management Infrastructure to Gain Cost and Operational Efficiencies and also to Extract Liquidity Risk Management Benefits

      The business case for upgrading collateral management capabilities is bolstered by placing liquidity risk management considerations squarely alongside the imperatives for improved credit risk management, processing efficiency, and cost savings. Collectively, such considerations are starting to drive implementation of unified target operating models, rationalized technology platforms, and greater automation within the world of collateral management.

      While focusing on just the credit risk–mitigating aspects of collateral narrows the field of vision considerably, the broader reality is that heightened volatility in fast-moving capital markets activities can trigger unexpected collateral calls which, in turn, can increase an institution's exposure to firm-wide liquidity risk. In such instances, the ability to identify and mobilize eligible collateral effectively, to both meet margin calls and increase access to secured financing, can become the key to economic survival.

      Integrate Collateral Management more Closely with Front Office and Treasury Functions

      Structural market reforms under the Dodd-Frank Act in the U.S. and the European Market Infrastructure Regulation are giving rise to greater pre- and post-trade transparency. At the same time, such reforms are also making market participation more expensive and operationally complex by requiring increasing quantities of high-quality collateral to be posted for both centrally-cleared and non-cleared swap portfolios. More stringent capital and liquidity regulations under Basel III require banks to hold greater quantities of the same high-grade collateral. The nexus of these different pressure points around collateral increases the business imperative to take a wide-angled lens view of how best to invest in cost-effective technology platforms and capabilities that can meet multiple business and regulatory requirements.

      As exchange-traded execution platforms begin covering an ever-broadening swath of the derivatives marketplace, clearinghouse cross-product margining will continue to grow. There will be renewed focus on reaching beyond the cheapest to deliver in order to fully exploit the collateral eligibility of each available asset with greater differentiation. Achieving effective integration and management of both collateral and liquidity requires moving the collateral management function away from being purely a back office function focused on credit risk toward a domain requiring closer collaboration between front office and treasury functions to better facilitate sound trade placement decisions and leverage collateral to its fullest liquidity potential.

      Optimizing Collateral Management Helps to Optimize Liquidity Risk Management

      Driven by the desire to source, fund, and allocate collateral efficiently, firms are focusing on achieving collateral optimization by putting in place cross-functional teams, rationalized operating models, common technology platforms, and proper collateral management processes. With optimization, leading market participants are starting to realize improved yield from each asset, minimize the cost of financing that asset, reduce capital charges associated with regulatory capital requirements, reduce liquidity risk, and eliminate over-collateralization. This represents the clear prize to be gained from combining capital and liquidity costs while simultaneously viewing collateral and liquidity as two sides of the same coin.

      Early Warning Indicators

      Select Internal Early Warning Indicators that Complement Market-Derived Measures

      Internally-focused early warning indicators (EWIs) provide a perspective on the liquidity profile and health of the institution. These measures are critical in understanding how the firm's liquidity position could be changing over time and what types of vulnerabilities may emerge as a result of business and strategic decisions.

      Leading institutions supplement their use of external EWIs with a suite of internally focused indicators. These internal measures should capture trends in specific markets and businesses in which the firm participates as well as those that serve as funding sources. Internal EWIs should be selected in concert with external EWIs to identify emerging risks and evaluate if the nature of these risks is idiosyncratic, systemic, or some combination of the two. Many institutions select broad stock or bond market indices as indicators of overall economic health; however, leading firms will focus on indicators that are specific to their business and funding profile, such as loan portfolio performance, operational loss metrics, or industry-specific bond and swap spreads. Specific indicators may alert management to market trends and warrant further investigation.

      Link the EWI Dashboard to a Strong Escalation Process

      Leading institutions select and calibrate EWIs and related thresholds to transmit meaningful signals to management about the need for corrective action in light of changes in the broader business environment or impending potential firm-specific distress. Once a EWI registers a change in status, a robust and well-established escalation process will help ensure that management (and potentially the board) reviews the trends to better understand the cause, identify the potential impacts of evolving business dynamics, and take appropriate actions. The firm's selection of EWIs and their calibration should be reviewed to reflect any changes to business mix and activities and the changing nature of the macroeconomic and market environments.

      EWIs should be forward-looking, selected so as to provide a mix of business-as-usual (BAU) and stressed environment information, and assessed against limits at predetermined intervals (e.g., daily, weekly, monthly). Continued deterioration in a single or combined set of EWIs should trigger the firm's emergency response tools, such as the contingency funding plan.

      Contingency Funding Planning

      Bring Contingency Planning to the Forefront and Align to Business and Risk Strategy Development

      The contingency funding planning (CFP) should serve as a critical component of the organization's liquidity risk management framework by ensuring that risk measurement and monitoring systems, such as liquidity stress testing, early warning indicators, limits, operating metrics, and regulatory ratios, are operationalized and drive timely management action in times of stress. The goal is accomplished most effectively by fully integrating the firm's risk identification СКАЧАТЬ