An interview with Terry Benzschawel, Managing Director, Institutional Clients Group, Citigroup
Our team at RiskMinds Live got to grips with the risks of credit reading with Terry Benzschawel ahead of this year’s RiskMinds Americas conference, taking place in Chicago this September…
What are the key risk challenges that you are facing today?
I see two possible main sources of risk and a couple of lesser ones. First, I see the US Fed’s exit from QE and that of the European Central bank as having the potential for unexpected consequences, particularly in light of the second factor, which is decreasing dealer inventories. My models are indicating a bifurcation of the risk premiums of bonds that the Fed buys (mainly US Treasuries and Agency mortgages) and ones not purchased (US corporates). This could be attributed to the former having greater liquidity, and the latter having relatively less liquidity. In the case of bonds with less expected liquidity, you may have sharper and larger price movements.” This bifurcation of credit risk is able to be seen in the differences in Citi’s Liquidity Index (the CLX) and our measures of embedded leverage (implicit funding in credit markets). The CLX is indicating extremely good market liquidity, but the cost of embedded leverage is as high as it has been since the credit conference. Lesser, but not unimportant sources of stress come from Britain’s potential exit from the EU, problems with the Greek economy feeding back to Europe, and the impact of the ever present threat of terrorism and extremists on markets
How do you see financial risk management changing in the next few years?
I see a greater reliance on quantitative methods on trader quotes and a more optimal relationship between sales, trading, and broker/dealer credit portfolios.
RiskMinds Americas takes place this September, what do you think will be the number one most pressing industry risk when we all meet for the conference?
The Fed’s exit is expected to have effects on the yield curve and the risk appetite of investors” Also, it may impact the overseas investments and the strength of the USD dollar. Treasury issues will likely be more attractive, but potentially result in mark-to-market risk for those currently holding US Treasuries. Also, it may impact the overseas investments and the strength of the USD dollar. However, the Fed’s exit “may” make it harder for corporations to raise money (higher yields to pay), thereby putting pressure on more risky firms, not only increasing risk of defaults and mark-to-market losses for existing corporate debt holders. Of course, higher yields may make newer corporate issues more attractive. The effects of all the unprecedented aforementioned factors and the interactions among them will likely require skilful actions on the part of investors.
Could you provide a snapshot of the insight you will be bringing to the conference?
An understanding of how to outperform credit benchmarks along with information gained from analysing client trade flows. In addition, I have devised unique, but validated, methods for neutralizing the effects of daily market moves on our global credit portfolios. Also, I have been analysing client trade flows and have been able to hedge our global inventory based on my measures of the credit risk premium and its relationship to changes in CDX.IG.
I will show how credit risky asset spreads to Treasuries can be broken into spread compensation for default and the spread compensation for price volatility. Although the default risk component of the spread is largely idiosyncratic, the price volatility component is largely systematic and can be measured, hedged, and predicted. We call this price volatility component, the “credit risk premium” and show first how to measure it. Then, depending on its level of risk, it can be hedged using the appropriate credit default swap indexes. Finally, it is possible to predict changes in the level of the risk premium from knowledge of its current level and the projected twelve-month default rate.
Visit the RiskMinds Americas website for full details of this year’s agenda and Terry’s involvement.
View the RiskMinds Live Blog for more exclusive industry insight.
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