Nothing focuses attention on a bank’s risk management desk than volatile markets. A brief period of shock can serve as a testing ground for existing frameworks whilst at the same time providing the opportunity for considering how the system can be strengthened.
Over a five-month period in 2015 – between April and September – the Hang Seng China Enterprises Index (HSCEI) lost 40% of its value, falling from a high of 14,900 points to 9,100. This hit structured products across Asia that were linked to the index. Korean autocallables were a prominent casualty.
This sharp shock to markets provided an early vindication for Commerzbank that overhauling its risk management systems in Asia – an initiative being spearheaded by Johanna Poinsitt, vice-president of group market risk management at the bank – was the right thing to do.
“The HSCEI fall in 2015 exposed a concentration risk that was widely missed in the market,” says Poinsitt. “We were able to quickly identify the concentration risk accumulating in our portfolio and targeted on diversification. The equity derivatives desk reduced index trades and focussed more on flow exotics products on stocks.”
But simply responding to the HSCEI fall through better diversification was not enough to satisfy the team that new concentrations were not building up elsewhere in the bank’s portfolio. “We need to be able to map every single exposure that we have in Asia,” explains Poinsitt, who has spent the past five years in Asia trying to reinvent the risk management team’s approach to meeting the bank’s regulatory and business objectives in the region.
Poinsitt’s approach to risk management hinges on the core belief that more value can be brought to the company if data from the market risk team and profit-and-loss data from the business control unit are combined. Although development of this new approach began before the 2015 market turbulence, the fallout from the HSCEI collapse served as a reminder of how important it is to have a clear picture of risk throughout the organisation.
“While traditionally discussions between the front office and risk managers would be done in the event of a limit breach, we are now able to approach this in a more proactive way before the breaches occur,” says Poinsitt.
An example of how this new approach prompted Commerzbank’s Asia equities team to rethink its trading strategy can be seen in Singapore, a market that accounted for 15% of the bank’s Asia stock-trading portfolio, according to Eric Michl, head of equity derivatives trading in Asia.
In autumn 2016, an enhanced analysis by Poinsitt’s team strongly suggested that Singaporean equity trades were far less profitable than trades in other markets. At the same time, the vega exposure of the mostly illiquid underlyings was costly to hedge, given a general lack of trading in the market towards the end of last year.
“Our data was a bit less granular than the data Joanna was able to provide,” says Michl. “We see things from a much broader asset-class perspective. Having access to more granular data made us reflect and helped to steer our approach.”
Commerzbank’s new risk management strategy has helped the firm become more profitable, as trading has been adjusted to capture more business in those areas with a better risk/return ratio. According to the bank’s internal metrics, between March and May this year, Commerzbank was able to reduce risk by 20% without losing any money on client trades. This risk reduction was largely due to ratios designed by Poinsitt and her team that looked at the amount of vega the bank was taking on compared to the cost of hedging this risk.
“If you don’t look at this properly, then you can run into situations where you are doing a lot of new trades but, because you can’t digest the risk properly, you lose as much or more than you put in the book in the first place,” says Poinsitt.
Poinsitt’s influence within the bank extends beyond Asia. Although she has spent the past five years redesigning Commerzbank’s approach to risk management in Asia, its success at driving profitability means that it will now be rolled out in the bank’s home market of Europe as well.
“Since the business in Asia is much smaller than in our home market, it was easier to trial the risk management system here first,” she says. “The merger between the market risk and business control units was a challenge in terms of cross-training and consolidation within the team. But, as our innovations show, this has been a success because we now have a more complete and dynamic view of the books.”