Today’s banking industry must deal with an evolving regulatory landscape by developing new and innovative strategies for acquiring and optimizing capital. Banks must find a new way to raise capital, maintain a functional capital structure, and continue providing the products and services their customers demand while staying profitable. The new deadline for implementing the Basel III capital requirements makes capital management the most important issue for banks today.

Bogie Ozdemir, Vice President, Risk Models and Governance, Sun Life Financial recently spoke with the Global Financial Markets Intelligence (GFMI) about key topics to be discussed at the upcoming GFMI 2nd Annual Capital Adequacy, Strategy And Stress Testing Conference, September 30–October 2, 2013, in New York.

What are the key implications of Basel III for capital adequacy and capital optimization?

Bogie Ozdemir: Basel III amounts to a climate change in the banking industry. It increased the capital requirements significantly — especially for certain businesses (most notably capital markets) and decreased the acceptable forms of capital. Capital has become a scarce resource under Basel III, putting significant downward pressure on ROE. In this new environment, Banks will need to change their business mixes, exit or shrink capital-heavy businesses, and adjust their operating models, while meeting income targets. During this course correction, their ROE and Income Targets will be challenged further as some rebalancing of operating models may compromise short-term income to improve ROE in future years. Subject to more onerous capital requirements under Basel III, banks will need to increase the efficiency of capital utilization and place greater emphasis on optimizing capital allocation and business mix across their operations.

How could banks integrate their regulatory and economic capital?

Bogie Ozdemir: Regulatory capital is a fact of life and cannot be ignored. The economic view of capital also must not be ignored, as most recently seen in the J.P. Morgan case where attempt to reduce RWA consumption resulted in massive increase in economic risk and, ultimately, losses. On the insurance side, products such as variable annuities emphasize the importance of understanding economic risks that may not have been covered by regulatory capital requirements. The first order of business is to control the regulatory capital, which becomes the binding constraint for certain business. But regulatory capital and economic capital must be co-managed. I have noticed some banks using more simplistic — but not very robust — ways of managing the two, such a creating a composite metric that is a mix of economic and regulatory capital. Banks should establish a more robust optimization framework, define an objective function (such as maximizing ROE), and define explicit relationships between regulatory, economic (and its stressed version), and available capital. This framework should be a part of their capital and strategic planning process.

What are the best sources of funding in this scarce capital environment?

Bogie Ozdemir: Contingent capital is becoming a viable source of funding undergoing concern. Junior Debt would be a source of capital under the “gone-concern” to protect deposit holders (and perhaps senior debt holders). By more carefully managing capital through ongoing and gone concern bases through an Economic Capital Framework, financial institutions can be more precise as to their required capital mix across common equity, senior debt, junior debt and hybrid instruments, and therefore minimize the average cost of capital.

How could you make sure stress testing results are integrated in capital strategy?

Bogie Ozdemir: We know from the last crisis that EC can increase significantly under stress — particularly when taking into account stressed inter and intra risk correlations. In their ICAAP/ORSA exercises, FIs define an explicit risk appetite under stress (minimum acceptable rating and capital adequacy) and ensure that they remain consistent with that risk appetite under a series of forward-looking conditional stress scenarios. As part of the Use Test under ICAAP and ORSA, FIs should demonstrate how the results of their stress testing and capital projection exercises have been incorporated into business planning decisions. In particular, the results of stress testing are used directly to inform the appropriateness of an FI’s capital buffer above its internal targets and whether the integrity of its capital structure is sufficient in stressed conditions. Degrees of vulnerability to stress must also be considered as part of capital optimization strategies.

Bogie Ozdemir is Vice President of Sun Life Financial Group, responsible for Enterprise Economic Capital, Operational Risk, Model Vetting & Risk Analytics, Risk Policy, and Economic Scenario Generation groups. He was a Vice President of the BMO Financial Group responsible for Economic Capital, Stress Testing, and Basel Analytics and jointly responsible for ICAAP. Previously, he was a Vice President of Standard & Poor’s Risk Solutions group, where he was globally responsible for engineering new products and solutions, business development and management. He is the coauthor of a book titled “Basel II Implementation: A Guide to Developing and Validating a Compliant, Internal Risk Rating System.”

The GFMI 2^nd Annual Capital Adequacy, Strategy and Stress Testing Conference will take place in New York, September 30–October 2, 2013. For more information, visit the event website.

For more information, please contact Michele Westergaard, Senior Marketing Manager, Media & PR, GFMI at 312-894-6377 or Michele@global-fmi.com.

About Global Financial Markets Intelligence

GFMI is a specialized provider of content-led conferences for the financial markets. Carefully researched with leading financial market experts, our focused quality events deliver key bottom-line value through targeted presentations, interactive discussions and high-level networking opportunities. 

Interview with Paul Emerson, Vice President, Asset Allocation, Risk Management at AllianceBernstein, L.P.

Operational risk management has moved beyond the simple calculation of capital requirements. Today operational risk managers need to have a proactive, holistic approach to operational risk to ensure they maintain their organizations’ profitability and reputation. Recent financial scandals have shown that operational risk could bring tremendous losses and not every firm is capable of recovering from them.

Paul Emerson answered a series of questions written by GFMI before the forthcoming Proactive Operational Risk Management Conference, September 9-11, 2013 in New York, NY. Mr. Emerson shares his thoughts below on why good change management starts with the right tone from the top.

How important are operational risks in the change management process?

Paul Emerson: Change represents one of the greatest stresses on our people, processes and systems. In fact, it would not be a stretch to think of change as a category of operational risk itself. Therefore, the business managers must take all the risks and controls that are implicated in the change into consideration to insure the process doesn’t break. Cutting corners on this review could ultimately place the client experience, and a new product or initiative’s commercial viability, at risk.

How do you develop strong working relationships between operational risk and product development teams?

PE: A strong working relationship is one that can only be built on mutual respect. I have found that the most important way to build this relationship is to show that the risk team’s involvement is one that adds value. It is not enough to just be present in the discussions. Rather, the risk management engagement should be limited to our areas of expertise and should be clearly defined and focused. Building this relationship is only part of the battle. It is equally important for the business leaders to see the benefit of the risk management’s engagement, as opposed to the potential costs. Without senior leadership support, this working relationship will have little chance of long term success.

How do you make sure operational risk is managed and controlled over the whole product life cycle?

PE: When the culture of the firm makes it clear that business managers are the primary line of defense for operational risk and are similarly incentivized, operational risk should theoretically always be managed throughout the whole product life cycle. In recognition of the experiential differences between the firm’s managers, AllianceBernstein has mandated that a full risk review of each new product be considered early in the product development process. Once the product is launched, we require a reconsideration of the department’s risk map, which (the catalogue or process level risks and controls) incorporates any material changes to the processes.

How do you make sure innovation is not restricted by operational risk threats?

PE: A critical skill of a good risk manager is the ability to think creatively so that they don’t restrict innovation. Risk managers should not be in the business of saying “no” unless it is absolutely necessary.  Rather, we are engaged by business managers to help them manage the concerns they have. If we get in the habit of stopping progress or slowing innovation, we will stop getting those calls. The best way to prevent this negative impact is to increase the dialogue between the business who is innovating, and the middle back office staff that is being strained. As a result of open and honest discussions, we can almost always find a compromise (delayed launch, limited release, increased technology support, etc.) that is satisfactory to all. 

What do you think attendees would gain by attending the conference?

PE: It is my hope that attendees will gain a better appreciation of all the elements that a company must have in place to properly manage their business through change. 

Paul Emerson is a Vice President and risk manager responsible for the coordinated risk management support for AllianceBernstein’s Asset Allocation business. He previously served as an operational risk officer for the Fixed Income and Technology business units and as the global head of error management.

For more information please contact Michele Westergaard, Senior Marketing Manager, Media & PR, marcus evans at 312-894-6377 or Michele@globalfmi.com.   

About Global Financial Markets Intelligence

GFMI is a specialized provider of content led conferences for the financial markets. Carefully researched with leading financial market experts, our focused quality events deliver key bottom line value through targeted presentations, interactive discussions and high level networking opportunities. 

The energy market is becoming increasingly competitive and volatile. The key to maintaining a competitive advantage is to develop effective hedging strategies and minimize risk exposure. With the new regulations introduced by the Dodd Frank Act, energy companies have seen a big change in their approach to hedging and they are on the look-out for establishing effective hedging strategies to value their assets and optimize their revenue.

Stephen Wemple, Vice President, Regulatory Affairs, Con Edison Competitive Shared Services recently spoke with Global Financial Markets Intelligence (GFMI) about key topics to be discussed at the upcoming GFMI Intelligent Hedging and Portfolio Optimization for the Energy Markets, October 24-25, 2013, in Houston. All responses represent the view of Mr. Wemple and not necessarily those of Con Edison and its subsidiaries.

A major topic of focus right now is the impact of swaps to futures on hedging strategies brought on by Dodd Frank. Can you explain your thoughts on what kind of impact this move to futures will have on hedging? Do you think energy companies will switch to the so called “futurisation” in order to avoid being a swap dealer?

SW: The trend from swaps to futures was highlighted by the conversion of all of the Intercontinental Exchange (“ICE”) products last year into futures. That decision takes significant pressure off larger energy producers and/or trading shops that may have otherwise been getting close to the $8 Billion de minimis threshold for potentially being classified as a Swap Dealer or the equivalent tests for Major Swap Participants.

With the increasing cost for hedging with OTC derivatives, do you think energy companies will reduce their hedging or will just hedge with futures instead? Is there still room for bilateral contracts?

SW: The increased cost may reduce some speculative trading but should not impact hedging activity which is determined by each company’s risk tolerance.  As for bilateral contracts, they have been under pressure even before implementation of Dodd Frank as credit concerns have increased the use of exchange brokers to clear transactions.  However, there is a real cost to clearing transactions that can be avoided if parties are willing (and able) to transact bilaterally.  As a result, we believe there will be a continuing level of bilateral contracts, albeit diminished from historical levels.

Living in the New Regulated Market: What needs to happen for energy companies to better understand how to implement Dodd Frank into their procedures?

SW: By now, I expect most companies have integrated reporting and record retention requirements into their internal procedures to ensure that the reporting party is clearly identified and each party understands their obligation as well as begun the process of obtaining board approval to use the end-user exemption.

One remaining challenge is the determination of what constitutes a hedge.  Unfortunately, CFTC has not provided much, if any, guidance; leaving companies to develop their own criteria for determining if a transaction is hedging commercial risk and can be considered a hedge. 

Impact on End Users: How will Dodd Frank affect their counterparties and their credit risk? Do you think that the new rules imposed by Dodd Frank will effectively reduce speculations and increase transparency in the market?

SW: From our perspective, the energy industry had already taken significant steps to address credit risk before the implementation of Dodd Frank such as clearing more transactions and providing credit support for bilateral contracts. 

One potential impact of Dodd Frank is it may constrain the types of energy products offered to municipal and governmental entities due to the lower de minimis threshold for Special Entities and smaller counterparties that may not have the capability to clear swaps or are not Eligible Contract Participants and are therefore not eligible to enter into swaps.

As counterparties shut down their swap-trading desks and shift their focus on exchange-traded products, end users fear that liquidity in bilateral markets will dry up. Is this worry warranted?

SW: The lack of bilateral liquidity and the increased use of exchange traded and cleared products does have an economic cost to market participants in the form of working capital to post initial margin and meet daily margin calls, but the trade-off is a reduction in the risk of the counterparty defaulting.

“The best option for energy traders is hedging physical assets.” Would you agree or disagree with this statement? Why?

SW: Clearing products on an exchange is clearly the most risk-averse way to execute hedges but may not be the most cost-effective, especially for those market participants that are entitled to elect the end-user exemption and transact bilaterally.

Stephen Wemple is the Vice President of Regulatory Affairs at Con Edison’s Competitive Shared Services company.  He represents Con Edison’s non-utility affiliates, Con Edison Development, Con Edison Energy and Con Edison Solutions in State and Federal regulatory proceedings and has been an active participant in the New York, New England and PJM wholesale markets. Mr. Wemple has worked for the Con Edison family of companies for 26 years with responsibilities ranging from resource planning for steam-electric generation, the design and implementation of energy efficiency programs, the development of retail access programs as well as marketing and business development for the wholesale and retail commodity businesses. Mr. Wemple received his Bachelor of Science and Master of Engineering degrees from Cornell University and has been a volunteer firefighter in New York since 1987.

The GFMI Intelligent Hedging and Portfolio Optimization for the Energy Markets Conference will take place in Houston, October 24-25, 2013. For more information, visit the event website.

For more information, please contact Tyler Kelch, Marketing Coordinator, Media & PR, GFMI at 312-894-6377 or Tylerke@global-fmi.com.

About Global Financial Markets Intelligence

GFMI is a specialized provider of content-led conferences for the financial markets. Carefully researched with leading financial market experts, our focused quality events deliver key bottom-line value through targeted presentations, interactive discussions and high-level networking opportunities. 

Operational risk management has evolved from the simple calculation of capital requirements to a proactive, holistic approach. This new strategy ensures that operational risk managers maintain their organizations’ profitability and brand reputation. In fact, recent financial scandals revealed that operational risk can result in incredible losses that many organizations can sometimes never fully recover from.

According to Ger Jan Meijer, Director of Operational Risk Management for Citco Fund Services (USA) Inc., there are several key steps that all organizations must take to develop a holistic approach to operational risk governance. Meijer will speak about operational risk at the Global Financial Markets Intelligence (GFMI) Proactive Operational Risk Management Conference, September 9-11 in New York. (Note: The views expressed in this interview are those of Ger Jan Meijer and are not necessarily representative of, and should not be attributed to, Citco Fund Services (USA) Inc.)

“Companies need to take risks to create value and manage risks to protect value,” Meijer said. “The challenge is to find and keep a good balance between risk and reward in a fast-changing and increasingly complex environment. Companies have to deal with new technologies, more regulations and even new disaster scenarios because of climate change. You need to find the risk before its finds you.”

Meijer pointed out that organizations must prepare for many types of operational risk, including:

• Internal Fraud: misappropriation of assets, tax evasion, intentional mismarking of positions and bribery.
• External Fraud: theft of information, hacking damage, third-party theft and forgery.
• Employment Practices and Workplace Safety: discrimination, workers compensation, employee health and safety.
• Clients, Products, and Business Practice: market manipulation, antitrust, improper trade, product defects, fiduciary breaches and account churning.
• Damage to Physical Assets: natural disasters, terrorism and vandalism.
• Business Disruption and Systems Failures: utility disruptions, software failures and hardware failures.
• Execution, Delivery, and Process Management: data entry errors, accounting errors, failed mandatory reporting and negligent loss of client assets.

“I believe that the Basel II event type categories are still a good starting point for an initial risk assessment,” Meijer said. “However, every organization has its own risk profile with different vulnerability levels for each category of risk.”

Meijer also pointed out that the most commonly overlooked operational risks inside an organization are those related to silos. “Silo mentality can result in a lack of understanding of operational risk as a driver for other risk types or could result in not identifying certain operational risks due to not fully understanding the entire process and interdependencies.”

This is the exact reason why Meijer emphasizes the importance of risk managers following a cross-silo (holistic) approach, which includes integrating the following strategies into their plan:

• Developing an organizational-wide view of operational risk, including determining the organization’s risk appetite.
• Designing and implementing a single, unified governance risk and compliance framework to identify, assess, mitigate and manage (monitor) risk.
• Developing systems to manage operational risk across different business units.
• Producing robust operational risk policies.
• Developing operational risk control matrices and risk reporting.

“It is not easy to objectively measure the added value of an effective operational risk management program,” Meijer explained. “However, certain statistics and trends can prove added value and success of an effective operational risk management program, e.g., incidents, KRI and KPI levels, client satisfactory surveys audit findings and exit interviews.”

As a speaker at the 2013 GFMI Proactive Operational Risk Management Conference in New York, Meijer looks forward to hearing from his risk management colleagues with other organizations about their challenges. “Operational risk management is a relatively new discipline and still in development,” he said. “I’d like to get new ideas about how to further develop the risk management framework of within my current organization.”

The GFMI Proactive Operational Risk Management Conference will take place in New York, September 9-11. For more information, visit the Proactive Operational Risk Management Web page or contact Tyler Kelch, Marketing & PR Coordinator, GFMI at 312-540-3000, ext. 6680 or tylerke@global-fmi.com.

About Global Financial Markets Intelligence

GFMI is a specialized provider of content-led conferences for the financial markets. Carefully researched with leading financial market experts, our focused quality events deliver key bottom-line value through targeted presentations, interactive discussions and high-level networking opportunities.