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Embedding Stress Testing
into Risk Management Processes
Date: 20/21 November 2006
Produced by: Kai D. Leifert
The materials may not be used or relied upon in any way.
ASSET MANAGEMENT
Roadmap





Stress testing in fund management
Regulatory Developments: UCITS III
Building the architecture for relevant results
Stress tests as part of strategic and operational risk processes
Making use of the results
Regulation
Stress
Testing within
Investment
Management
Integration in
the firm’s risk
management
Use of
Results
Architecture
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 2
Stress testing in the fund management industry
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 3
Actionable stress testing?
Propriatary assets…
Limits
Policies
Authority
Measure
risks and
stress tests
Measure
all risks




Evaluate
portfolio
mix
Decide on
risk capital
& allocate
Full authority and influence over trading position
Directly related to company revenues
Diversification effects across the portfolio
Can be budgeted and allocated
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 4
Actionable stress testing?
… versus client assets.
Manage PF
according
client mandate
Measure
specific risks
of clients
Measure
risks and
stress tests
Evaluate
whether
portfolio is in
line with client
expectations
Evaluate
impact of
markets on
revenues
Refine
product
distribution
strategy
 Limited influence over trading position
 Only indirectly related to company revenues
 Sometimes little diversification across clients

(i.e., an asset management boutique)
No reallocation of assets but may be used to
steer product management process
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 5
Regulatory framework
 UCITS III
– Established structure under German requirements

Regular monthly stress tests required
 Ad-hoc stress tests required when markets or portfolios changed
 Results may provide evidence that risk system is sufficient in capturing
risks from new instruments/products
– Stress tests in the context of Luxembourg law

Useful in the context of the Luxemburg commitment approach as it proofs
adequacy of compliance/investment guidelines
– Expectations in the UK

Clear expectation that stress testing becomes part of regular risk
management processes
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 6
Building the IT architecture
 Current problems
– Incoherent architecture with multiple systems and various reports
– Varying data quality in different locations
– No single source of security information across portfolios (i.e., each portfolio
–
is administered by a different custodian)
Computation time
 Ideal Requirements
–
–
–
–
Single source of security information in the firm
Single database from where risk and stress testing information are derived
Single scenarios across portfolios
Portfolios may be aggregated across product lines
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 7
Sample Architecture & Considerations
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 8
How to achieve…
 Regulatory compliance
 Supportive infrastructure


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

Management information
Transparency through results
Explanation of adverse results
Support of portfolio construction
Improved performance results
A marketing tool through stress testing
Identification of gaps in current product range
Identification of products that are not consistent with market trends
Effective Stress test Reporting
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 9
Recipient specific requirements (1)
Portfolio Managers, Risk Management
 Level of detail: High
 Reporting: Ad-hoc or regular
 Scenarios: According to portfolio
management strategy
 Creation time: Medium, existing
risk systems may be used or can
be accessed by the end-user
 Benefits
– Transparency of risks
– Can be used for portfolio
–
construction purposes
Evaluate effects on client portfolios
under assumed market conditions
Sources of Returns - Global
Currency
Asset Class
Equity
Risk Free Return
Model Return
Selection
Total Daily Linked Return
Factor
Equity
Europe (GICS Industry Group)
Automobiles & Components
Banks
Capital Goods
Comm Services & Supplies
Consumer Durables & Apprl
Consumer Services
Diversified Financials
Energy
Food & Staples Retailing
Food Beverage & Tobacco
Health Care Eqpt & Srvcs
Household & Prsnl Prods
Insurance
Materials
Media
Pharmaceuticals & Biotech
Real Estate
Retailing
Semiconductors & Semi Eq
Software & Services
Tech Hardware & Equipment
Telecomm Services
Transportation
Utilities
Total
ASSET MANAGEMENT
Contributions to Return (%)
Portfolio
Benchmark
-0.234
0
-6.911
-7.074
-0.339
0
0.059
0.046
-7.425
-7.028
0
0
-7.425
-7.028
Portfolio
97.695
Exposure
Benchmark
100
Net
-2.305
0
17.736
6.579
0
0
2.89
4.501
11.157
5.029
5.774
0
0
7.301
4.664
2.141
9.791
0
3.061
1.961
1.999
0
7.56
2.434
5.422
100
3.695
18.509
6.745
0.254
2.963
1.03
5.727
8.371
1.758
3.809
0.565
0.948
6.266
6.509
3.097
3.939
0.919
0.588
0.845
1.964
3.195
8.005
2.031
8.267
100
-3.695
-0.773
-0.166
-0.254
-2.963
1.86
-1.227
2.786
3.27
1.965
-0.565
-0.948
1.036
-1.844
-0.957
5.852
-0.919
2.473
1.116
0.035
-3.195
-0.445
0.403
-2.845
0
Net
-0.234
0.163
-0.339
0.012
-0.397
0
-0.397
Factor(%)
Return
-8.658
-2.696
0.262
1.024
-6.522
-9.508
-3.621
-0.758
2.221
3.098
0.994
2.193
-3.448
-2.968
-0.624
5.598
0.99
-2.546
0
5.551
14.928
7.838
-3.871
1.322
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 10
Recipient specific requirements (2)
Risk Management, Regulatory Bodies, and External Auditors
 Level of detail: Medium
 Reporting: Regular
 Scenarios: Standard scenarios
across risk factors
 Creation time: Low, existing risk
systems may be used and can be
created via batch files
 Benefits
– Comparison of risk factors across
–
portfolios
Review of changes to portfolios
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 11
Recipient specific requirements (3)
Senior Management, Product Management, and Risk Management
 Level of detail: Low
 Reporting: Regular
 Scenarios: Most stressful
scenarios across product lines
 Creation time: High, aggregation
may be time consuming
 Benefits
– Impact of market environment can
–
be evaluated
Gaps in the product range can be
identified and closed
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 12
Key Success Factors…
…for embedding stress testing into the overall risk management
processes
 Gather buy in from the front office and senior management
 Identify scenarios that are relevant to the recipients
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

– Stressful enough
– Focus on complex, nonlinear, asymmetric risks
– Address linkages between risks across product lines
– According to management style
Provide relevant and concise reporting
– Focus level of detail on recipients
Update for previously unidentified risks
Develop governance structure for the communication of results
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 13
Important information
This document was produced by CREDIT SUISSE (hereafter “bank") with the greatest of care and to the best of its
knowledge and belief. However, the bank provides no guarantee with regard to its content and completeness and does not
accept any liability for losses which might arise from making use of this information. The opinions expressed in this
document are those of the bank at the time of writing and are subject to change at any time without notice. If nothing is
indicated to the contrary, all figures are unaudited. This document is provided for information purposes only and is for the
exclusive use of the recipient. It does not constitute an offer or a recommendation to buy or sell financial instruments or
banking services and does not release the recipient from exercising his/her own judgment. The recipient is in particular
recommended to check that the information provided is in line with his/her own circumstances with regard to any legal,
regulatory, tax or other consequences, if necessary with the help of a professional advisor. This document may not be
reproduced either in part or in full without the written permission of the bank. It is expressly not intended for persons who,
due to their nationality or place of residence, are not permitted access to such information under local law. Every
investment involves risk, especially with regard to fluctuations in value and return. It should be noted that historical returns
and financial market scenarios are no guarantee of future performance. Investments in foreign currencies involve the
additional risk that the foreign currency might lose value against the investor's reference currency. © 2006 Copyright by
CREDIT SUISSE
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 14
Speaker Biography
Mr Kai Dirk Leifert joined the Asset Management Division of Credit Suisse in April 2001.
Since then he was heading the risk management function in Germany till October 2005.
In this role Kai was responsible for the oversight and monitoring of investment risks of all
institutional and mutual funds as well as the operational risk management framework.
During 2004 he also gained responsibility for all compliance related activities in the
German business. Kai relocated to London by the end of 2005 to support the London
business and to work together with the Global Head of Traditional Asset Management
Risk Management in designing the global risk architecture. He is now responsible for
both, the implementation and coordination of investment risk related issues for the Asset
Management Division of Credit Suisse globally. Before joining Credit Suisse he was
working at ING Diba as an advisor in consumer banking.
Kai Leifert is affiliated with the Global Association of Risk Professionals and a member of
their financial risk manager (FRM) committee. The FRM committee sets standards in the
risk management area and designs the yearly certification exam.
ASSET MANAGEMENT
Produced by: Kai D. Leifert
Date: 20/21 November 2006 Slide 15