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KONDOR+ HELPING BANKS TO MEET CHANGES IN MARKET PRACTICE AND REGULATION Kondor+: Helping banks to meet changes in market practice and regulation The financial crisis in 2007/2008 highlighted a number of weaknesses within the markets: ineffective counterparty risk management; a lack of transparency; and exposure to systemic risk when one counterparty default cascaded into defaults for other parties. Risk management failings were prominent across market participants and acted as a catalyst for regulatory changes. Post-2008, banks struggled to reinvent themselves, driven by regulatory change and the introduction of new market practice: the implementation of EMIR, Dodd-Frank and Basel III is imminent; while new practices such as multiple-curve pricing, OISdiscounting and liquidity charge computation at price discovery have become market standards. In short, we have seen the biggest shake-up in the market since its inception, with banks now tasked with delivering increased capital requirements, tighter risk monitoring, and more frequent reporting. Changes to their organization, processes and systems are all too often needed to ensure compliance with the new demands. 1 Brochure Fortunately, Kondor+ continues to evolve to meet the post-crisis changes in regulatory and market practice. Working closely with customers, Misys has been able to fast-track new features into Kondor+, tailored to the specific requirements of individual banks, and all from a single integrated platform. This enables Misys’ customers to meet their regulatory obligations, while continuing to pursue growth strategies safe in the knowledge that their Kondor+ deployment will also continue to evolve to support their business goals. Kondor+: Helping banks to meet changes in market practice and regulation FROM SINGLE CURVE TO MULTI-CURVE Kondor+ enables banks to comply with new market practices requiring multiple curves to discount derivatives and evaluate forward rates. Before 2007, the swaps market priced and traded off a simple set of yield curves. Then, the financial crisis brought a distortion of interest rates. Basis spreads, which had previously been minimal, widened to a point that could no longer be ignored. The spread between the Overnight Index Swap (OIS) rate and LIBOR existed before 2007 but it was constant and very small – to the extent that everyone assumed that OIS and LIBOR were interchangeable. This is no longer the case. Additionally, differences in value between collateralized and uncollateralized trades (negligible before 2008 thanks to small basis spreads and low volatility) were now becoming material. The old way of valuing derivatives with a single master swap curve for discounting and projecting forward rates was no longer viable. This recognition has led to a significant shift in market practice, with the abandonment of the single-curve pricing methodology and the adoption of a modern, multiple-curve approach. As the market became more and more aware of the credit and liquidity risks associated with short-term interbank lending, liquidity and credit premiums began to be paid on interbank LIBOR funding. This meant that LIBOR rates of different tenors showed varying amounts of credit/liquidity spread, and this increased with term. As basis spreads widened, it was no longer possible, for example, to price a 6-month swap off a forward swap curve where the underlying was a 3M rate. To comply with the new market practice today banks need to be able to build multiple forward rate curves for forward LIBOR, reflecting 1M, 3M, 6M and 12M tenors. A second dynamic relates to the discounting of collateralized trades. Credit Support Annex (CSA) collateralization agreements were previously used by banks as a way of mitigating counterparty risk. OIS discounting is now the market standard. The OIS yield curve is recognised as being essentially free from credit or liquidity risks, built as it is on the prices of OIS swaps subject to overnight margining. Issues relating to discounting curves are also being shaped by ISDA regulations. To be consistent with these new standards, different sets of discounting curves could be required. For example, for the five major currencies (USD, EUR, JPY, GBP, CHF), the OIS curve should be used for discounting while for other currencies, the USD OIS rates should be used for single currency instruments. This means that for a vanilla IRS in PLN, the PLN discounting curve should be implied from the EUR OIS rates. FX rates for EUR/PLN are required to do this: FX points for the short term and currency basis spreads for the long term. In this way, the implied yield curve will depend on at least one other yield curve. A more sophisticated, more accurate approach is required. banks must ensure that their valuation processes, systems, and reporting are able to handle both a discount curve and a forward curve, across all asset classes, for counterparties with or without collateral agreements, based on different currencies. Brochure 2 Kondor+: Helping banks to meet changes in market practice and regulation Specifically, banks must have the capability to handle: • Swaps pricing where the collateral is in a different currency; • Pricing of non-collateralized swaps; • Specification of cross-currency swap curves. Kondor+ now includes a multi-curve module to calibrate yield curves coherently and flexibly and enable different scenarios to be associated to each curve and to each type of instrument. Different curves can be assigned to reflect: • Discount or forward usage; • In the case of forward usage, the appropriate underlying index (3M LIBOR, 6M LIBOR, etc.); • In the case of discounting usage, the collateral information (CSA, CCP...) • Currency; • Type of deal. The discounting curve can be easily calibrated to take account of a CSA currency that is different from the deal currency; while risk management of the different curve dependencies is also facilitated. Kondor+ Multiple-Curves module: A Snapshot • Easy calibration of discounting curves, taking account of CSA agreements as a parameter for curve assignment • Ability to build dedicated curves in accordance with the underlying tenor - deposits, futures, FX points, FRAs, swaps, single-currency basis swaps, and cross-currency basis swaps • Differentiated funding curves for counterparties with and without collateral agreements (LIBOR vs. OIS discounting) • Calculation of risk exposure for all market data inputs 3 Brochure Kondor+: Helping banks to meet changes in market practice and regulation CONNECTING FOR CCP Kondor+ now offers a standard interface with MarkitWire, allowing customers to manage the whole CCP trade workflow as required by Dodd-Frank and EMIR . The 2008 financial crisis occurred in part due to the lack of transparency in the trading and processing of OTC derivatives, which account for almost 95% of all derivatives trades. G-20 world leaders reacted with an agreement that all standard OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central clearing counterparties (CCPs), in order to reduce systemic risk. The agreement filtered into the Dodd-Frank Act in the US and the European Market Infrastructure Regulation (EMIR).Bilateral clearing will gradually disappear, to be replaced by a CCP that will intervene between the two counterparties in a transaction designed to manage the counterparty risk; the CCP becomes the buyer to every seller and the seller to every buyer. Different players have a role in the CCP trade workflow: the affirmation platform that provides post-trade execution functionality; the trade repository that makes it possible to see a firm’s underlying position and exposure from a central vantage point; and the clearing members that act as a liaison point between buyers and the CCP for all post-trade functions, including daily margin management. There are currently about a dozen CCPs clearing OTC derivatives based on interest rates, credit, equity and commodities. The challenge facing financial institutions has been the need to incorporate the necessary connectivity, calculation engines, configurable rule-based workflow and specific reporting requirements into their current systems. And speed is of the essence. This transformation of the capital markets is happening at a rapid pace. With a deadline set by the G20 of 31 December 2012, the players involved need to move fast. A key requirement of systems is to provide connectors to the CCP workflow. MarkitSERV connects dealers and their clients to CCPs, trade repositories and third-party administrators, through an unparalleled network of participants and services. Kondor+ now offers a standard interface with MarkitSERV’s MarkitWire system, allowing customers to handle the whole trade workflow as required by the new regulations (trade, novation, clearing and so on). Kondor+ delivers standard reporting enabling users to monitor their transaction flows, control their margin requirements and handle the end-of-day process. Coupled with the existing Kondor+ Collateral Management module, customers can now face the new regulatory requirements from a single platform. MarkitWire Connectors: A Snapshot • MarkitWire deal workflows: –– Dealer to Dealer –– Broker to Dealer • Supporting the following events: –– New trade –– Amendment (unilateral, bilateral) –– Cancellation –– Termination (full, partial) via the amend function –– Novation (full, partial) • Support for interest rate swaps & swaptions • Support for other instruments can be added on request Brochure 4 Kondor+: Helping banks to meet changes in market practice and regulation BASEL III: DRIVING ACTIVE CVA MANAGEMENT New functionality within Kondor+ helps the trading desk to price correctly for CVA and to manage counterparty credit risk more effectively, while the Risk team can manage the total CVA position, in full compliance with new regulatory requirements. A credit value adjustment (CVA) captures the counterparty default risk inherent in OTC derivatives portfolios. CVA is a highly volatile figure that depends directly on fluctuating daily market prices. The potential cost of doing business with certain counterparties is now a significant concern for anyone trading in the financial markets. In the past, the valuation of counterparty credit risk (CCR) was largely ignored, thanks to the relatively small size of derivatives exposures and the high credit rating of the counterparties involved - in general, other highly rated financial institutions. But as the size of derivatives exposure increased and the credit quality of the counterparties fell in the wake of the financial crisis, the valuation of CCR could no longer be assumed to be negligible and had to be properly reflected in a fair value calculation of the financial instruments. This increased focus on counterparty risk is being driven by new regulations: • EMIR in Europe and Dodd-Frank in the US, which will require standard derivative contracts to be cleared via a CCP. Non-cleared derivatives will require higher capital requirements. • Basel III, which is introducing more capital buffers and is also bringing in additional requirements for the CCR and the CVA value at risk (VaR). The new regulatory requirements for CVA come into force from January 2013. They will drive a more proactive management of CVA, since hedging CVA positions will result in a lower capital requirement, and hence increased trading profitability for banks. A fundamental challenge facing financial institutions is to integrate CVA-specific requirements into their existing organizations and IT architectures. The way this is done depends on a number of decisions. 5 Brochure CVA for compliance or for profit he level of CVA management sought (to measure, T advise, hedge or trade) will differ from bank to bank, depending largely on the strategic direction and the size of the derivatives book. Smaller banks may apply CVA purely to comply with accounting and Basel III rules; more advanced trading operations will look beyond compliance and will try to make money out of their CVA desks. Dedicated or modular CVA desk anks may opt for a dedicated CVA desk, or B implement CVA in a modular way, with each trading desk managing its own CVA position. The dedicated CVA desk would compute and manage the bank’s global CVA positions and levy charges on the different trading desks as a ‘price for protection’. The trading desks would require the CVA protection costs at the pre-trade level, so that they could be included in each trade’s fair value, and charged to counterparties. The more proactive the stance taken towards counterparty risk the greater the need to have the right IT solution in place to handle the quantification, pricing and management issues that accompany CVA. Reporting capabilities must incorporate two distinct views - a consolidated view for the risk management department or CVA desk, and the trader view. The CVA desk or Risk Management department tends to be primarily interested in aggregate CVA figures, but would also need drill-down capabilities to support the validation of the figures and to enable them to answer requests from the trading desks to approve new deals. Aggregated views usually follow counterparty and instrument hierarchies and must show the netting and collateral agreements that are in place in a transparent manner. If hedging is to be handled by a CVA desk, CVA sensitivities must be provided. Kondor+: Helping banks to meet changes in market practice and regulation Traders are primarily interested in pricing (which means knowing how much to add as CVA), current CVA amounts and details of any defined limits. They also need guidance as to which counterparties are favored or should be avoided, and on whether or not a new transaction will ‘pass’. Their most important requirement is a quick response time. A view of the counterparty hierarchy and details of existing transactions, including collateral that is already blocked, will help in mitigating default risk and in detecting cases of possible wrong way risk. If a trader is tasked with hedging counterparty credit risk, then he/she will also need access to CVA sensitivities. New functionality within Kondor+, building on the already extensive foundations for CVA, helps customers to ensure full compliance with the new Basel III requirements, by mapping the CVA charge to the individual trade in Kondor+ and also showing the impact on the P&L. Kondor+ helps traders to make better trading decisions and price correctly for CVA at the pretrade level, providing reporting tools for computing the CVA, P&L and Greeks (PV01, CS01 and crossGammas) on ‘netting sets’. The ability to aggregate these Greeks is necessary for managing and hedging the resulting credit position. For the CVA desk, Kondor+ enables CVA charges to be allocated to the different trading desks and trading books and enables the desk to manage the overall CVA position. The ability to map the CVA charge to the individual trade provides the transparency and drill-down that is required today. The new CVA functionality is fully integrated into Kondor+. CVA charges can be imported from Misys Global Risk (MGR) or an external system, or a simple ‘add-on’ can be done using a rules engine. CVA/Basel III: A Snapshot –– Creation of the CVA service –– CVA charges can be imported from MGR or an external system, or a simple ‘add-on’ can be done using a rules engine –– CVA charges can be computed at the pretrade level –– CVA service can be called at the trade level, or on a batch mode (end of day CVA charge reporting) –– CVA charges can be transferred to the CVA desk Forward Premium Quotations This is a new convention - some of the swaption and FX OTC Option quotation have moved form spot premium to forward premium quotation. This new market practice was driven by two factors: firstly, due to the new OIS Discounting changes, there was no agreement as to how discounting should be done; and secondly, as a result of the increased awareness of CCR. If the premium is paid on a spot basis and the counterparty defaults, then a loss is incurred. If the premium is paid forward, there is no credit risk. Kondor+ now enables the management of forward premiums for swaptions and FX OTC options. Brochure 6 MISYS RECENT MARKET RECOGNITION NUMBER ONE TECHNOLOGY PROVIDER RISK TECHNOLOGY RANKINGS 2012 Number One Overall – All Categories Number One Overall – Trading Systems Number One Trading Systems – Equities Number One Trading Systems – Rates Number One Trading Systems – Forex Number One Trading Systems – Inflation Number One Pricing and Analytics – Equities Number One Regulatory and Compliance Reporting STRUCTURED PRODUCTS TECHNOLOGY RANKINGS 2012 Number One Trading System – Credit Number One Trading System – Cross Asset Number One Trading System – Foreign Exchange Number One Trading System – Rates Number One Risk Management – Collateral Management BEST TRADING PLATFORM BACK OFFICE ASIAN BANKER TECHNOLOGY AWARDS NUMBER ONE RISK MANAGEMENT TECHNOLOGY PROVIDER ASIA RISK TECHNOLOGY RANKINGS 2012 Number One All Categories Number One Derivatives pricing and risk analytics Number One Operational risk management Number One Derivatives pricing and risk analytics – Equities Number One Derivatives pricing and risk analytics – Interest Rates Number One Derivatives pricing and risk analytics – Hybrids LEADING SINGLE TECHNOLOGY PLATFORM – PORTFOLIO, TRADING AND RISK MANAGEMENT HEDGE FUND JOURNAL AWARDS 2011 STRUCTURED PRODUCTS TECHNOLOGY RANKINGS 2011 Number One Trading System – Equities Number One Trading System – Interest rates Number One Pricing and Analytics – Equities BEST RISK MANAGEMENT INITIATIVE ASIA ASSET MANAGEMENT AWARDS ABOUT MISYS Misys is at the forefront of the financial software industry, providing the broadest portfolio of banking, treasury, trading and risk solutions available on the market. With 1,800 customers in 120 countries our team of domain experts and partners have an unparalleled ability to address industry requirements at both a global and local level. Misys was formed by the merger of Misys with Turaz, which includes the award-winning Kondor+ product line. Combined they are able to address all customer requirements across both the banking and trading book businesses. Misys is the trusted partner that financial services organisations turn to for help solving their most complex problems. Misys and the Misys “globe” mark are trade marks of the Misys group companies. Copyright © 2012 Misys. All rights reserved. Find out more at www.misys.com 9537 / 1212