GARP Webcast

Aligning Liquidity Compliance and the

Business A Three Step Approach
Presented by:

Gudni Adalsteinsson
Head of Global Liquidity, Group Treasury, Legal & General Group Plc

Nicolas Kunghehian
Director Solutions Specialist, Moody's Analytics
Pierre Mesnard
Director, Solution Specialist, Moody's Analytics

June 25, 2015

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Gudni Adalsteinsson, Legal & General Group Plc

Gudni Adalsteinsson is the Head of Global Liquidity at Legal & General,
responsible for the overall liquidity and cash management. His experience
ranges from running the group treasury for a European bank during the
credit crunch, working for the Financial Services Authority, to providing
liquidity advice to UK banks. Adalsteinsson was a group treasurer for an
Icelandic bank during the unprecedented liquidity shocks of 2008, which
offered him first-hand experience of liquidity risk management under severe
crisis. Between the years of 1998 and 2005, he was an executive director at
Lehman Brothers and Credit Suisse in London and Frankfurt, advising
German banks on their liquidity and structured credit investments. He has
been a board member of banks in the UK and Denmark.
Adalsteinsson holds an MBA degree from the University of Cambridge and a
bachelors degree in economics from the University of Iceland. He is the
author of the book, The Liquidity Risk Management Guide from Policy to
Pitfalls (Wiley, 2014)

Nicolas Kunghehian, Moodys Analytics

Nicolas Kunghehian is a Director, Solution Specialist at Moodys Analytics. He
joined Moodys Analytics via Fermat in 2005, working as a specialist on our
Asset and Liability Management, and Regulatory Compliance Solutions.
Before joining Moodys, Nicolas had over six years experience as an ALM and
risk manager in two French Banks, Credit Agricole and Caisse Nationale des
Caisses dEpargne.
Nicolas holds a mathematics and economics degree from the Ecole
Polytechnique and a finance and statistics degree from the Ecole Nationale de
la Statistique et de lAdministration Economique, two prestigious French
Grandes Ecoles.

Pierre Mesnard, Moodys Analytics

Pierre Mesnard is a Solution Specialist at Moodys Analytics. Based in
Paris, he works closely with Financial Institutions across the EMEA region,
advising them on how effective liquidity management and compliance can be
implemented with Moodys Analytics.
Pierre joined Moodys Analytics in 2007, and prior to joining, Pierre was a
project manager in a consulting company where he advised major industrial
groups on their IT infrastructure and processes.

Pierre holds a Telecommunications Engineering degree from Tlcom

ParisTech (France).

Liquidity Risk Challenges

Agenda

The Data Conundrum

BASEL III Opportunity To Get It Right!
The Adequate Framework

The Data Conundrum

Sets liquidity risk management apart from other risk factors in

banking
The reason for liquidity risk management still being relatively young
Impacts the whole spectrum of liquidity risk management from
academic research to cash flow projections
Lack of standardisation of definitions and methods, BASEL III the first
attempt to set the playing field
Will change the future research methods and methodologies

The Data Conundrum, cont.

Example where lack of data drives liquidity management

PWC, Balance Sheet Management Benchmark Survey, Status of Balance Sheet Management
Practices among International Banks 2009, and PWC, April 2010
8

BASEL III
Opportunity To Get It Right!

BASEL III Opportunity To Get It Right!

10

Prescribed definitions on what is low risk, retail etc.

Management tool or compliance exercise?
100% LCR = GOOD, 99% LCR = BAD?
Forecasting LCR > Important feature and data requirement

BASEL III Opportunity To Get It Right!

Bank A

NSFR Solution

Standardised assumption and view on the balance sheet

Not being able to forecast NSFR levels bring high level of risk and
inefficiency

11

BASEL III Opportunity To Get It Right!

To fix one only problem albeit a big one: Maturity Mismatch

12

The Adequate Framework

13

A Recipe for an Adequate Framework

List of essential ingredients

Cash flow projections

Stress testing
Contingency planning, early warning indicators and risk metrics
Policies

Governance structure
Funds transfer pricing (FTP)
Monitoring, reporting and an escalation framework
How to get the ingredients to stick together?

14

The 6 Step Framework

6. Reporting &
management
information
5. Stress testing
and CFP
4. Quantitative
framework
3. Governance and
high level policies
2. Risk Appetite
1. Sources of
liquidity risk

15

Determining the Stability of Funding Scorecard Approach

(50 Shades of Grey)
Channel
premium
(1-5)
Unsecured debt, branch network
1 Retail, branch network - covered by DGS
1.1 part of an established relationship making withdrawal highly unlikely;
held in a transactional account, incl. accounts to which salaries are regularly
1.2 credited.
1.3 other, covered
2 Retail, branch network - not covered by DGS, but less than 500k
3 Retail, branch network - not covered by DGS, >500k
4 SME, branch network - covered by DGS
4.1 part of an established relationship making withdrawal highly unlikely;
4.2 held in a transactional account
4.3 other, covered
5 SME, branch network - not covered by DGS
5.1 part of an established relationship making withdrawal highly unlikely;
5.2 held in a transactional account
5.3 >500k
5.4 Other (i.e. non -transactional <500k)
6 NFC (non-financial corporates), branch network
6.1 part of an established relationship making withdrawal unlikely;
6.2 held in a transactional account
6.3 >500k
6.4 other (i.e. non -transactional <500k)
Unsecured debt, internet channel
7 Retail, internet channel - covered by DGS
held in a transactional account, incl. accounts to which salaries are regularly
7.1 credited.
7.2 other, covered
8 Retail, internet channel - not covered by DGS, but less than 500k
9 Retail, internet channel - not covered by DGS, >500k
Unsecured debt, treasury
10 NBFI (non-bank financial institutions),
10.1 part of an established relationship making withdrawal unlikely;
10.2 held in a transactional/custody account
10.3 other
11 Governments, central banks and supranationals
10.1 part of an established relationship making withdrawal unlikely;
10.2 held in a transactional account
10.3 other

16

Not DGS
Rate
Response
No other
Size
covered sensitivity
to neg.
relationship premium
(+3)
(1-5)
news (1-5)
(1-5)
(1-5)

Total
Score

1
1
1
1

1
1
1
2

1
1
1
1

2
2
2

1
1
1

1
1
1

2
2

3
5
5

3
2

7
9
13
11

4
3

7
9
14
10

3
3

1
1
1

2
4

3
5
10
13

1
1
1
1

3
3
3
3

1
1
2
1

2
2
2
2

2
2
2

1
1
1
1

3
3
3

1
1
2
2

2
2
2
2

2
2
2

3
3
3
3

2
2
2
2

3
4

11
11
17
18

3
3
3
3

3
3

3
3
3
3

5
5
5

3
3
3

3
3
5

3
4
4

2
2

4
4
4

18
21
23

5
5
5

3
3
3

3
3
5

3
4
4

2
2

4
4
4

18
21
23

Determining the Stability of Funding Scorecard Approach

Stability I
Stability II
Stability III
Stability IV
Stability V
Stability VI
Stability VII
Weighted average score:

Total
Score
Amount $
<5
4,500
5-10
3,000
>10
1,500
<10
4,000
>10
1,500
<20
300
>20
700
6.5
15,500

%
29%
19%
10%
26%
10%
2%
5%
100%

The above categories can be the ones set out in BASEL III
One or two sets of data?
+ Standardisation
- One size fits all bulk approach
+ Eliminated confusion
+ Cost
+ Will become a local requirement
17

Scenario Stress Testing

Bank A: Liquidity Stress Test Scenarios

The following test are conducted monthly and reported to ALCO and senior management

No

18

Firm-specific/ market
wide/ Combination
Working title
1
C
GREEN

Business as usual

Creditworthiness I

Sudden event leading to a drop in market confidence

Creditworthiness II

Prolonged lack of market confidence

Operational failure

IT failure leading to client payment failures

YELLOW

All major stress factor started to strain

Northern Rock

Adapted Northern Rock style scenario

AMBER

EuroZone

Market trouble

All stress factor materially affected, incl. collateral

Wide interbank disruption due to Eurozone problems or
break-up
On going disfunction of the interbank markets

10

Creditworthiness III

11

9/11

12

RED

Short Description

Sudden event leading to progressively deterorating situation.

Contingency actions included
Global market wide disruption across markets and products
Severe outflow of deposits, interbank market in crises mode,
market for collateral disrupted, increased haircuts

- Liquidity holding requirement set according to AMBER results

- For stress assumptions see 'Liquidity Stress Testing -Assumptions and methods' in 2014 ILAA
-In addition to the 12 scenarios ALM has monitored the outcome of 4 other models

Scenario Stress Testing

Scenario 2: Sudden drop in market confidence

19

Scenario Stress Testing, cont.

20

Liquidity Compliance and

Business Management
Feedback From the Market

21

Evolution of Liquidity Management

Before the liquidity crisis

Treasury was the only department dealing with Liquidity Risk
Liquidity Risk was considered as small
P&L was the main objective

Over the last years

Liquidity spreads => lower P&L
Risk of bankruptcy => more risk
Regulatory pressure => more reports to produce
Data governance
Stress testing => more data in a short period of time
Consolidated reports => different jurisdictions
Top management => internal communication
22

Before the Crisis

Only one team in charge

Treasury or ALM department
Strong expertise
Customized internal tools

Three horizons
Intra day liquidity management
Short term
Long term

23

New Missions

1. Liquidity risk management

Treasury or Risk Department
First internal stress tests
Top management involvement

2. Regulatory pressure
Principles for sound liquidity risk management and supervision
Stress tests in some countries
3. Internal costs
Daily reports
Strategic vs tactical tools

24

New Trends

1. Enterprise risk management

Integrating all risks in one single framework
BCBS 239
Monitoring all the costs (Funds Transfer Pricing)

2. Regulatory impact
LCR cannot be calculated with Excel tools => need for industrialization
Managing the ratios and their volatility
3. Performance monitoring
Governance
Liquidity Transfer Pricing

25

Three Steps to Delivering

Integrated Liquidity Compliance
and Business Management

26

Three Steps to Delivering Integrated Liquidity Compliance and

Business Management

1. Modelling financial instruments / cash flow generation (or import)

Maturing products / Non maturing products
Off balance sheet commitments / Derivatives
Liquid / illiquid asset (contingency funding plan, liquidity buffer)

2. Implementing compliance rules and setting internal liquidity policy

Regulatory inputs (haircuts, eligibility criteria, run offs)
Scenarios behavioural assumptions (shifted run offs, prepayments)
3. Reports disclosure
Regulatory reports (LCR / NSFR, ALMM, FSB)
Consolidation
Internal liquidity dashboards
27

What Do We Mean by Unified Data Platform ?

Granular data loading and checking needed
- Easier to aggregate information when available rather than trying to get /
guess missing information

A mix between risk and finance information

- Cash flows projection based on Financial Characteristics
- Security classification criteria based on Risk profile (Rating, Asset Class,)

Consolidation of the entire balance sheet

- All products coming from all business lines
- Solo and group calculations (definition of transferable rules)

A central repository to simplify all adjustments process

Delivery of results with full and comprehensive auditability

28

Implementing a Unified Platform Offers to Go Beyond

Regulatory Compliance
Implementing
a Unified Platform Offers

Go Beyond Regulatory Compliance

Regulatory
Regulatory
Compliance
Compliance

Liquidity
Liquidity
Management
Management
Best
Practices
Practices

Stress
Stress testing
Testing
methodologies
Methodologies

29

to

Liquidity
Liquidity
Pricing
Pricing

In Addition to Regulatory Requirements, Banks Can Set Up

Their Proper Liquidity Management

In Addition to Regulatory Requirements, Banks

Can Set Up Their Proper Liquidity Management
Framework
Short Term
Medium Term
Scope

Ensures that the bank can be financed

safely via secured short term funding

Enable the bank to forecast liquidity

requirements to sustain its activity / strategy
for the coming months / years

Calculation Frequency

Daily or weekly

Monthly
N scenarios:
- on going,
- systemic crisis,
- specific (downgrade),
- specific + systemic crisis
-

Stress Testing Scenario

Time Horizon

Maturities monitored are 1D, 2D, 1W

until 3M

Perimeter
Approach

30

Maturities Monitored are 1M, 3M, 6M, 12M,

18M, 24M and 36M (not limited)

Consolidated/Entity level
Static approach

Dynamic approach

Regulatory Indicators Used to Complement Internal

Liquidity Metrics

Regulatory Indicators Used to

Regulatory
Indicators
Used to Metrics
Complement
Internal Liquidity
With increasing
pressure
regulators,
banks
tend
Complement
With
increasingfrom
pressure
from
regulators,
banks
tend
Internal
Liquidity
Metrics
toautomated
relyincreasing
on more automated
process
to generate
final
to rely on more
process
to regulators,
generate
final
With
pressure
from
banks
tend
regulatory
returns
to rely on more automated process to generate final
regulatory returns

Process should be run daily

Full audit trail

toAudit
understand
calculation
and
hastotounderstand
be recorded
-adjustments
Full
trail
calculation
andtrack
track
adjustments
has to be
recorded
adjustments
has
to be recorded
Regulatory
metrics
have been widely incorporated in

- Process
run daily calculation and track
Full Auditshould
trail tobe
understand

their dashboard
: e.g.
LCR
forecast
now a standard
Regulatory metrics
have
been
widely
incorporated
in in
Regulatory
metrics
have
been
widelyis incorporated
ratio
to
monitor
liquidity
theire.g.
dashboard
: e.g. LCR forecast
a standard
their dashboard:
LCR forecast
is nowisanow
standard
ratio
to monitor
liquidity
- liquidity
Based
on regulatory
parameters (run off, Eligibility
ratio to monitor

regulatory
returns
- Process should
be run daily

) regulatory parameters (run off, Eligibility

-criteria
Based on

Based on regulatory
parameters
criteria
) models
- Based on
developed(run
by theoff,
bankeligibility
criteria) - Based on models developed by the bank

Data consolidated for regulatory purpose are also

widely
reused
in Balance
simulations
better
Based on
models
developed
bySheet
the bank
Data
consolidated
for regulatory
purpose aretoalso
capturereused
Liquidity
risk
widely
in Balance
Sheet
simulations
to better
Data consolidated
for regulatory
purpose
are also
capture
risk costs used by commercial unit
- BetterLiquidity
reflect liquidity

widely reused in balance sheet simulations to better

Impactreflect
of liquidity
costs
on Banks
Interest Income
- Better
liquidity
costs
used byNet
commercial
unit
capture liquidity risk

31

Liquiditycosts
Cost on Banks
EVE Net Interest Income
- Impact of liquidity

Better reflect- Impact

liquidity
costs used by commercial unit
of Liquidity Cost on EVE

Impact of liquidity costs on banks net interest income

Impact of liquidity cost on EVE

Creating
a culture of Stress Testing
Best
Practices
risk awareness

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