Risk Management

Learning Objectives

  1. Impact of LIBOR/RFR transition on risk management.
  2. Working through model validation – simulations, quantitative changes and documentation.
  3. Conducting simulations and quantitative impact analysis, e.g. recallbration of historical parameters, for P&L, MTM and limits.
  4. Impact on derivative and cash versus instruments, e.g. swaps vs. bonds.
  5. Managing risk limit modifications, e.g. LIBOR vs. SOFR DV01.
  6. Addressing hedge breaks, e.g. cash/derivatives, impact of convention difference.
  7. Management of non-quantitative risks – operational, regulatory reporting, etc.
  8. Management of LIBOR transition timelines, e.g. across currency exposures across U.S. and  Europe/other jurisdictions.
  9. Preparing for regulatory interactions – documentation of changes and inspections.
  10. Addressing changes in internal and external reports, e.g. LIBOR being replaced by several RFRs + credit.

Course Framework

1. Overview of LIBOR and How We Got Here

  • Genesis of LIBOR, its composition and mechanics
  • IBOR as a global benchmark and foundational challenges
  • 2008 Global Financial Crisis and necessity of LIBOR replacement
  • Overview of the LIBOR BOOTCAMP program

2. RFR Indices Across All Currencies Worldwide and Its Conventions

  • Mapping from original LIBOR indices to the new RFR indices and how accrual and cashflow calculations are defined for RFR indices
  • Conversions for USD, EUR and GBP and what we can expect from the current OIS rates
  • Detailed description of new vanilla trade conventions for all currencies and indices
  • Detailed description of fallback trade conventions for all currencies and indices

3. Mechanisms of the Transition Fallback and its ISDA Adjustment

  • Relationship among pre-cessation, announcement, and trigger dates
  • Detailed fallback calculation algorithm
  • Routes for banks to transform current LIBOR portfolios

4. Cash Instruments

  • Scope and size of cash instruments and markets
  • Challenges specific to cash markets
  • Definitional Overview
  • Consent Solicitation
  • ARRC Recommended Fallback Language for all types of instruments
    • Floating Rate Notes
    • Bilateral Business Loans
    • Syndicated Loans
    • Securitization
    • Adjustable-rate Mortgages (ARMs)

5. Derivatives - New Payment and Accrual Conventions

  • Differences among 1M SOFR, 3M SOFR, Eurodollar and Fed Fund future
  • Reasons for calculation differences
  • Differences of payment and accrual conventions among fixed income, lending and derivatives
  • Listing of reliable rate calculation engines for reconciliation of payments
  • Detailed examples of payment gap, lockout, observation shift and observation period shift
  • Reset in Advance SOFR option products

6. Quantitiative and Modeling Topics

  • Futures Conventions and Convexity Adjustments
  • Average vs Compounding Swaps
  • Introduction to FMM as an extension of LMM
  • New cap/floor conventions to hedge student loans
  • Volatility decay during RFR term rate period
  • Approximate volatilities using a proxy

7. Model Validation Overview

  • Managing Model Risk for LIBOR Transition
  • Impact of Incorporating LIBOR Fallback on Models
  • Understand the Impact of Discounting Switch
  • Incorporating SOFR and other Overnight Rate Characteristics and Behavior
  • RFR Curve Construction Blind Spots and Challenges

8. P&L Impact on Fallback Date and Its Implications

  • Significance of value transfer for existing Libor contracts
  • Impact on counterparty exposure, collateral and xVA measures
  • Impact of tax treatment on the decision- making process for transition timing
  • Limits and risk mitigation on potential fallback P&L impact
  • Exposure measures and hedging of LIBOR SOFR basis spread

9. LIBOR Market Model Introduction and FMM

  • Difference of Transition Impact on Hull&White and LMM
  • Review of LMM and it’s Underlying Behavior
  • Issues with LMM and Reset in Arrears Backward Looking Rates
  • Model Changes based on Lyashenko and Mercurio
  • Deterministic Volatility Decay Function and Ease of Implementation

10. Impact on Existing Model Libraries

  • Fixed Income models and methodologies
  • Derivatives models and methodologies
  • Modifying and adjusting for RFR replacement differences
  • Managing model risk management workflow

11. Risk Management

  • LIBOR transition impact on system and institutional risk
  • How to identify, measure, monitor and control LIBOR transition risks
  • Principal risk factors such as rates and credit (xVA)
  • Client management and communication
  • Impact on Risk control and Finance

12. Curve Construction of new RFR Indices

  • Recommended Curve Instruments across USD, GBP and EUR for RFR
  • Comprehensive List of New RFR Instruments for Curves
  • Which Rates to use for FX Forward Interest Rate Parity
  • Cross Currency Basis and timing in US and other Jurisdictions
  • New Mechanisms in Curve Construction for SOFR
  • How to reconcile to CME and LCH curves after PAI change

13. Regulatory and Legislative Initiatives

  • Details of the involvement of specific regulatory bodies
  • List and summaries of proposals in 2020 and upcoming 2021
  • RFR Working Group Touch Legacy Task Force overview
  • OCIE Risk Alert examination on LIBOR transition
  • Impact on consumer finance related legislation and regulation

14. Consent Solicitation

  • Diversity of Consent Solicitation based on Asset Class
  • Consent Solicitation for English Law Legacy Bond Contracts
  • Operationalizing consent solicitation
  • New York State legislative measures

15. Fallback Language and Waterfall

  • ARRC Recommended Fallback Language for Securitization
  • ARRC Recommendations on Fallbacks for Adjustable-rate Mortgages (ARMs)
  • ARRC Recommended Fallback Trigger Language for new issue FRNs
  • European Central Bank (ECB) Guidance on Fallbacks for Euro Rates

16. Fannie Mae and Freddie Mac LIBOR Transition Playbook

  • Single family ARMS and securities
  • Single family credit risk transfer
  • Collateralized mortgage obligations
  • Multifamily ARMS.MBS, FRNs and credit risk transfer

17. Redocumentation Risk, Broken Hedges and Hedge Cashflow Mismatches

  • Management of timing differences when assets, liabilities convert to LIBOR
  • Impact of client vs Street swap payment conventions on hedge slippage
  • Analysis of impact of observation period shifts on projected vs realized cashflows
  • Ability to achieve exact hedge between loans and swaps
  • Basis risk for illiquid callable SOFR swaps
  • Decomposition of a LIBOR swaps into OIS and SOFR swaps

18. Impact on Interest Rate Option Products

  • New cap/floor conventions to hedge student loans
  • Fannie and Freddie options demands for caps
  • Current option products traded for RFR
  • Difference of Eurodollar convexity adjustment from SOFR futures
  • Impact of CCP discounting switch on bi-lateral Swaptions
  • Impact of fallback on swaptions and caps and floors
  • Introduction to extending LIBOR market model to backward-looking rates

19. Risk Management for Fixed Income Instuments

  • Fixed income limit and risk control framework
  • Overview of specific risk parameters and greeks
  • Risk control and management workflow
  • Limit violations and mitigation

20. LIBOR Transition Impact on Financial and Non-Financial Principal Risks

  • Identification of risks introduced with LIBOR replacement RFRs
  • RFR replacement data sources and management
  • Impact on models and recallbration
  • Process and documentation risks

21. Incorporating Replacement RFRs/Fallback Characteristics and Behavior

  • Components of RFR curve documentation
  • Case Study of RFR documentation – zero curves
  • Interpolation techniques and choice
  • Market data and curve reallingment

22. Impact on Existing Model Libraries

  • Fixed Income models and methodologies
  • Derivatives models and methodologies
  • Modifying and adjusting for RFR replacement differences
  • Managing model risk management workflow

23. Risk management workflow and impact of LIBOR replacement

  • Identification of incremental risks
  • Model bencharking
  • Case Study of RFR impacts
  • Alignment and explanation of MTM differences

24. Regulatory Reporting and Guidance on Model Risk Management

  • Risk policies and governance
  • Analysis and internal reporting
  • Impact on model risk management framework
  • Alignment of internal and regulatory reporting

25. Principles of Quantitative Model Validation and Model Risk Management

  • Definitions of Model, Model Risk and Input/Output/Engine components
  • Model Uses across the Enterprise using Practical and Closed Form Calculations
  • Required Processes for Model Validation for Fundamental Changes or Rates
  • Apply Quant Culture with IT Discipline to Manage Transition

26. LIBOR Transition Impact on Curves, Option Models, Cashflows and Accruals

  • New Instruments and New Forward Rate Behavior
  • Updated Accrual and Payment Conventions
  • Required Modifications to Forward Rate Convexity Adjustments
  • Mismatch Patterns due to Business Days Weightings and Quarter/Year End Spikes
  • Temporary Need for Volatility Proxies due to Lack of Liquidity
  • Implied Volatility Intra-Period adjustments and Decays

27. New Model Risk Contributing Factors

  • Econometric Model Changes for the the new Risk-Free Rates
  • Backward and Forward Looking Term Rates and Shift of Effective Dates and Accrual Dates
  • FAS133 Hedge Effectiveness Testing Changes for new Benchmarks and Transition
  • Statistical Behavior of the new Rates and Credit Components
  • Model Risk Contributing Factors and Changes in Market Regime
  • New or Untested Model Type or Class

28. Model Users and their Expectations

  • Behavior and Expectations of Traders and Business Decision Makers
  • Risk Management across Enterprise and Desk level
  • Financial Controls and Accounting
  • Regulators and Policymakers and Expectations on Transition

29. Vanilla/Static, Dynamic and Credit Models

  • Term Structure Models for Interest Rates
  • Market-Implied PD and LGD Models
  • Actuarial-Statistical PD, Risk Migration and Loss Models
  • Stochastic Models for Equity,FX and Commodity

30. LIBOR Usage and Major Components of Required Model Changes

  • Compounding, Averaging and Daily Observation Impact
  • Curve and Collateral Dependency Revision across all Currencies
  • Move from HJM/LMM to FMM Model
  • Convex Accrual Function across all Asset Classes
  • Funding and Loan Index Recommendations to Account for Credit Component of LIBOR
  • Timeseries Considerations and Historical SOFR model to have data back to 1998

31. Dynamic Mortgage Models with Current Coupon, Prepayment and Credit

  • Stochastic Interest Rate Models and CMS Rates as Inputs
  • Current Coupon Model and lack of SOFR History
  • Prepayment, Default, Loss Severity Models
  • Structured Securities and Collateral LIBOR assumptions

32. Hands-on New Payment and Accrual Conventions for FRN and Swaps for Reconciliations

  • Differences among 1M SOFR, 3M SOFR, Eurodollar and Fed Fund future
  • Reasons for calculation differences
  • Differences of payment and accrual conventions among fixed income, lending and derivatives
  • Listing of reliable rate calculation engines for reconciliation of payments
  • Detailed examples of payment gap, lockout, observation shift and observation period shift
  • Reset in Advance SOFR option products

33. Build the Short End of the RFR Curve and Cross-Currency Basis

  • Instruments to define LIBOR, RFR, OIS curves and their relationships
  • Interest rate parity for FX forwards and if RFR will have an impact on FX projections
  • Impact of RFR on the cross-currency basis in the short end of the curve
  • Implementation of the short end of the curve and implied likelihood of Fed Fund rate
  • changes
  • Multiple different overlapping futures contracts in a single curve
  • SOFR term rate and futures

34. Build the Long End of the RFR Curve and Cross-Currency Basis

  • Many alternatives to build the long end of the curve
  • Removal of LIBOR dependency on the SOFR curve
  • Long end discussion with SOFR outright vs basis to OIS or LIBOR
  • Necessity for multi-curve bootstrapping when SOFR swap discounts on SOFR

35. Deriving Volatilities for A Proxy Index

  • Generalized dynamic model of Mercurio
  • Deriving SOFR volatilities from LIBOR volatilities
  • Numerical examples of shifted lognormal
  • Numerical examples of SABR replication

36. Impact of small SOFR convention discrepancies to discount factors

  • Curve dependency examples and how it affects errors in zero rates
  • Pricing examples for swaps and it’s curves and reconciliation impact
  • Payment and accrual convention impact on zero rates
  • Pricing examples for swaps and it’s curves and reconciliation impact

37. Smooth Interpolation with Various Interpolation Techniques

  • Desirable features of any interpolation techniques
  • Quite comprehensive view of interpolation techniques
  • Different interpolation methodologies on zero, forward rates and discounting factors
  • Can linear methods have continuity in forward rates?
  • Spline methods and mentioning of Hermite interpolation as well as Hagan’s monotone convex method

38. Pitfalls of Flat Daily One Day Forward Rates and FOMC Meeting Dates

  • Implied jumps in forwards due to FOMC meeting and future expiration dates
  • Curve generation algorithm in detail combining overlapping futures
  • Can you build a good forward rate curve with bootstrapping or do you need an optimization across instruments
  • Large spikes in forwards close to FOMC meeting dates

Program Expert Faculty

Sanjay Sharma - LIBOR Bootcamp

Sanjay Sharma, PhD

Chairman GreenPoint Financial
Former CRO, RBC Global Arbitrage and Trading and Natixis, North America

During 2007-16 Sanjay was the Chief Risk Officer of Global Arbitrage and Trading Group and Managing Director in Fixed Income and Currencies Risk Management at RBC Capital Markets in New York. His career in the financial services industry spans over two decades during which he has held investment banking and risk management positions at Goldman Sachs, Merrill Lynch, Citigroup, Moody’s and Natixis. more…
Tim Glauner - LIBOR Bootcamp

Tim Glauner

Head of Capital Markets Global Solution Consulting for Americas, Finastra

Tim leads the Americas’ Capital Markets practice, Global Solution Consulting at Finastra, specializing in front-office, risk and quantitative areas in capital markets for broad asset class coverage including interest rate/inflation/FX/hybrid derivatives, fixed income including corporate and ABS/MBS securities. more…