ING Direct 2009 Annual Report Download - page 217

ING Bank
The Corporate Market Risk Management department (CMRM) is the designated independent department that is responsible for the
design and execution of the bank’s market risk management functions in support of the ALCO function. The CMRM structure recognises
that risk taking and risk management to a large extent occurs at the regional/local level. Bottom-up reporting allows each management
level to fully assess the market risk relevant at the respective levels.
CMRM is responsible for determining adequate policies and procedures for managing market risk and for monitoring the compliance
with these guidelines. An important element of the market risk management function is the assessment of market risk in new products
and businesses. Furthermore CMRM maintains an adequate limit framework in line with ING Bank’s risk appetite. The businesses are
responsible for adhering to the limits that ultimately are approved by ALCO Bank. Limit breaches are reported to senior management
on a timely basis and the business is required to take the appropriate actions to reduce the risk position.
Market risk in trading books
Organisation
Within the trading portfolios, positions are maintained in the professional financial markets for the purpose of benefiting from short term
price movements. Market risk arises in the trading portfolios through the exposure to various market risk factors, including interest rates,
equity prices and foreign exchange rates.
The Financial Markets Risk Committee (FMRC) is the market risk committee that, within the guidelines set by ALCO Bank, sets market risk
limits both on an aggregated level and on a desk level, and approves new products. CMRM advises both the FMRC and ALCO Bank on
the market risk appetite of Commercial Banking activities.
For the trading portfolios, CMRM focuses on the management of market risks of Commercial Banking (mainly Financial Markets) as this is
the only business line where significant trading activities take place. Trading activities include facilitation of client business, market making
and proprietary position taking in cash and derivatives markets. CMRM is responsible for the development
and implementation of trading risk policies and risk measurement methodologies, the reporting and monitoring of risk exposures
against approved trading limits and the validation of pricing models. CMRM also reviews trading mandates and limits, and performs
the gatekeeper role in the product review process. The management of trading market risk is performed at various organisational levels,
from CMRM overall down to specific business areas and trading offices.
Measurement
CMRM uses the Value at Risk (VaR) methodology as its primary risk measure. The VaR for market risk quantifies, with a one-sided
confidence level of 99%, the maximum overnight loss that could occur due to changes in risk factors (e.g. interest rates, foreign exchange
rates, equity prices, credit spreads, implied volatilities) if positions remain unchanged for a time period of one day. The impact of historical
market movements on today’s portfolio is estimated, based on equally weighted observed market movements of the previous year. ING
uses VaR with a 1-day horizon for internal risk measurement, control and backtesting, and VaR with a 10-day horizon for determining
regulatory capital. ING’s VaR model has been approved by the De Nederlandsche Bank (DNB: the Dutch Central Bank) to be used for the
regulatory capital calculation of its most important trading activities.
Market risk management for the fixed income and equity markets is split into two components: general market risk and specific
market risk. The general market risk component estimates the VaR resulting from general market-value movements (e.g. interest rate
movements). The specific market risk component estimates the VaR resulting from market-value movements that relate to e.g. the
underlying issuer of securities in the portfolios. This specific risk relates to all value movements not related to general market movements.
CMRM has implemented a historical simulation Value at Risk model for consolidated risk reporting for the trading books that has
replaced the Variance Covariance method used previously. ING has chosen to use a phased rollout approach and as of 1 January 2009,
implemented the first phase after approval from DNB. In this first phase, calculations for linear portfolios and equity derivative positions
have changed from variance-covariance to historical simulation. Most of the other non-linear risks and specific risks are still measured by
Monte Carlo, or variance-covariance, methods. In due time, all non-linear and specific risks will be replaced by actual historical simulation
results mainly based on full revaluation. The harmonization of VaR methodologies is one of the main targets of CMRM for 2010.
Limitations
VaR as a risk measure has some limitations. VaR uses historical data to forecast future price behaviour. Future price behaviour could differ
substantially from past behaviour. Moreover, the use of a one-day holding period (or ten days for regulatory calculations) assumes that all
positions in the portfolio can be liquidated or hedged in one day. In periods of illiquidity or market events, this assumption may not hold
true. Also, the use of 99% confidence level means that VaR does not take into account any losses that occur beyond this confidence level.
The Basel Committee has proposed to supplement the current VaR regulatory capital framework for trading exposures with e.g. an
Incremental Risk Charge (IRC) and Stressed VaR to cover for the shortcomings of the current risk framework. The IRC will ensure that
Basel II capital charges will capture certain risks which are not reflected in the current 99%, 10-day VaR model for the trading book such
as defaults and credit migrations. The Basel II requirements on the incremental risk charge will come into force from 2011 onwards.
2.1 Consolidated annual accounts
Risk management (continued)
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