We develop an analytic framework that synthesizes current approaches to sustainable portfolio management in the context of addressing climate change. We discuss the different required information layers, approaches to emissions accounting, attribution and forward-looking limit frameworks implementing carbon budget constraints.
The frontpage graphic is adapted from Steffen et al. “Planetary Boundaries: Guiding human development on a changing planet". Science (2015). The Planetary Boundaries concept was proposed in 2009 by this group of Earth system and environmental scientists. The group suggested that finding a “safe operating space for humanity” is a precondition for sustainable development. The framework is based on scientific evidence that human actions since the Industrial Revolution have become the main driver of global environmental change.
In this second Open Risk White Paper on "Connecting the Dots" we examine measures of concentration, diversity, inequality and sparsity in the context of economic systems represented as network (graph) structures.
Concentration, diversity, inequality and sparsity in the context of economic networks In this second Open Risk White Paper on Connecting the Dots we examine measures of concentration, diversity, inequality and sparsity in the context of economic systems represented as network (graph) structures. We adopt a stylized description of economies as property graphs and illustrate how relevant concepts can represented in this language. We explore in some detail data types representing economic network data and their statistical nature which is critical in their use in concentration analysis.
In this Open Risk White Paper, the first in a series of three, we introduce and explore the concept of federated credit systems as a potentially interesting domain for the application of federated analysis and federated learning.
Federated Credit Systems, Part I: Unbundling the Credit Provision Business Model: As an architectural design and information technology approach, federation has received increased attention in domains such as the medical sector (under the name federated analysis), in official statistics (under the name trusted data) and in mass computing devices (smartphones), under the name federated learning.
In this (the first of series of three) white paper, we introduce and explore the concept of federated credit systems.
Connecting the Dots: Economic Networks as Property Graphs: We develop a quantitative framework that approaches economic networks from the point of view of contractual relationships between agents (and the interdependencies those generate). The representation of agent properties, transactions and contracts is done in the a context of a property graph.
A typical use case for the proposed framework is the study of credit networks.
You can find the white paper here: (OpenRiskWP08_131219)
Is the IFRS 9 or CECL standard more volatile? Its all relative! Objective In this study we compare the volatility of reported profit-and-loss (PnL) for credit portfolios when those are measured (accounted for) following respectively the IFRS 9 and CECL accounting standards.
The objective is to assess the impact of a key methodological difference between the two standards, the so-called Staging approach of IFRS 9. There are further explicit differences in the two standards.
Credit Portfolio PnL volatility under IFRS 9 and CECL: Objective We explore conceptually a selection of key structural drivers of profit-and-loss (PnL) volatility for credit portfolios when profitability is measured following the principles underpinning the new IFRS 9 / CECL standards
Methodology We setup stylized calculations for a credit portfolio with the following main parameters and assumptions:
A portfolio of 200 commercial loans of uniform size and credit quality Maturities extending from one to five annual periods A stylized transition matrix producing typical multiyear credit curves Correlation between assets typical for a single business sector and geography portfolio Focusing on PnL estimates one year forward, with PnL being impacted both by Realized Losses (defaults) and Provision variability (both positive and negative).
Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era: The post-crisis world presents portfolio managers with the significant challenge to asimilate in day-to-day management the variety of conceptual frameworks now simultaneously applicable in the assessment of portfolio credit risk:
The first major strand is the widespread application of regulatory stress testing methodologies in the estimation of regulatory risk capital requirements The second major strand is the introduction of new accounting standards (IFRS 9 / CECL) for the measurement and disclosure of expected credit losses
The new IFRS 9 financial reporting standard: IFRS 9 (and the closely related CECL) is a brand new financial reporting standard developed and approved by the International Accounting Standards Board (IASB).
Strictly speaking IFRS 9 concerns only the accounting and reporting of financial instruments (e.g. bank loans and similar credit products). Yet the introduction of the IFRS 9 standard has significant repercussions beyond financial reporting, and touches e.g., bank risk management as well.
What are European Safe Bonds? While the creation of the eurozone was a landmark of the European integration process, the financial crisis highlighted that the eurozone remains an incomplete design which can lead to unpredictable and adverse situations in the event of a (the) next major crisis. One of the key such incompleteness features of the current eurozone architecture is that it does not have a truly risk-free (safe) euro debt instrument: one that continues being serviced (avoids a default event) at virtually any point in time and state of the world, no matter how severe.
Risk Capital for Non-Performing Loans: Currently many countries are drowning in bad credits This visualization from the World Bank shows the current distribution of non-performing loans (NPL’s in short) around the world, as fraction of the total outstanding loans:
Translated in absolute numbers (according to IMF data) the European NPL book alone stands at around 1 trillion EUR.
As the adage goes, a trillion here, a trillion there, you pretty soon talk about serious money
From Big Data, to Linked Data and Linked Models: The big data problem:
As certainly as the sun will set today, the big data explosion will lead to a big clean-up mess How do we know? It is simply a case of history repeating. We only have to study the still smouldering last chapter of banking industry history. Currently banks are portrayed as something akin to the village idiot as far as technology adoption is concerned (and there is certainly a nugget of truth to this).
FX Lending Risk:
A stress testing methodology for analyzing FX lending risk. Extends standard credit risk modelling tools to capture the increased risks of FX lending in a consistent way
Financial Weapons of Mass Destruction Warren Buffet famously declared financial derivatives as weapons of mass destruction (although apparently this did not prohibit him from using them when convenient). The leverage afforded by such contracts, their potential complexity, or simply their novelty which may imply lack of understanding, are some reasons why one would classify them as potential contributors of systemic risk, which is a polished rephrasing of the more popular this sucker is going down quote.
Business Model Risk - The Forgotten Risk Type: Sustainable business models that demonstrate adequate profitability over long horizons are key to a healthy market economy. This applies to firms and organizations of any size and in any sector. But how do we determine what is sustainable and how can we tell a risky business structure from a stable one?
On the small-scale end of the size spectrum we have the domain of startups and SME’s.
Seven Heavens of Finance and the Open Risk API: Back-to-basics is not salvation It has become trendy since the financial crisis to be wearing an anti-complexity hat in matters concerning the shape of the financial system. This is an understandable reaction to the entangled constructions that had sprung to existence in the hyper-leveraged markets of the naughty noughties.
Yet shifting through the ruminations and proclamations one cannot help but get the impression that there is a sort of denial of the complexity that underlies the real economy.
Unbundling the Banks: A How To Guide: Talk of unbundling the banks is all the rage these days (if we believe the fintech startups). Yet upon closer inspection one gets the feeling that these optimistic people might not necessarily know exactly what they are trying to unbundle, the true complexity of a medium to large bank, which in turn reflects, at least in part, the complexity of our modern financial system.
Open Risk API: If you work in financial risk management you will most likely recognize where the following sentence is coming from:
One of the most significant lessons learned from the global financial crisis that began in 2007 was that banks information technology (IT) and data architectures were inadequate to support the broad management of financial risks. This had severe consequences to the banks themselves and to the stability of the financial system as a whole For those lucky few risk managers not being affected by inadequate IT systems, the excerpt is from the Basel Committee’s Principles for effective risk data aggregation and risk reporting (2013).
The mystery of the collapsed cathedral: You walk to the center of an old city and you see its glorious cathedral lying in ruins. What in the world has happened here? Your investigative instinct goes into overdrive. This is not supposed to happen. Not in peacetime anyway. How can it be that this magnificent edifice, after gracing the town’s central square for who knows how many centuries, is now little more than a rubble pile in the center of town?
Revisiting simple concentration indexes:
Our white paper Revisiting simple concentration indexes reviews the definitions of widely used concentration metrics such as the concentration ratio, the HHI index and the Gini and clarify their meaning and relationships.
This new analytic framework helps clarify the apparent arbitrariness of simple concentration indexes and brings to the fore the underlying unifying concept behind these metrics, thereby enabling their more informed use in portfolio and risk management applications.
Criteria for identifying simple, transparent and comparable securitisations: (See BIS D304)
Our view is that securitisation is fundamental financial technology and there is no intrinsic technical reason why it could not be harnessed to best serve the functioning of modern economies.
We believe, though, that a comprehensive overhaul of historical securitisation practices is the best means of addressing the stigma that has been attached to it in the follow up to the recent financial crisis.
Open Risk Presentation summarizing the Public Beta Phase: Overview of the motivation for initiating Open Risk and the solutions being delivered in the current phase.
Venue: Online Location: The world Time: September 18th 2014 Link to presentation: Open Risk Overview
