American Express 2005 Annual Report Download - page 47

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balance sheet exposures and foreign currency earnings
generally do not qualify for hedge accounting. Derivative
hedging activities related to translation exposure of for-
eign operations generally qualify for hedge accounting.
With respect to cross-currency charges and balance
sheet exposures, including related foreign exchange for-
ward contracts outstanding, the effect on the Company’s
earnings of a hypothetical 10 percent change in the
value of the U.S. dollar would be immaterial as of
December 31, 2005. With respect to foreign currency
earnings, the adverse impact on pretax income of a 10
percent strengthening of the U.S. dollar related to antici-
pated overseas operating results for the next twelve
months, including related foreign exchange option con-
tracts entered into in January 2006, would hypotheti-
cally be $65 million as of December 31, 2005. With
respect to translation exposure of foreign operations,
including related foreign exchange forward contracts
outstanding, a 10 percent change in the U.S. dollar
would result in a $12 million reduction in equity as of
December 31, 2005.
In conjunction with its international banking opera-
tions, the Company also uses derivative financial instru-
ments to manage market risk related to specific interest
rate, foreign exchange and price risk exposures arising
from deposits, loans and debt and equity securities
holdings as well as its limited trading positions, dis-
cussed below. At December 31, 2005 and 2004, interest
rate products related to trading and non-trading posi-
tions with notional amounts totaling approximately $17
billion and $12 billion, respectively, were outstanding.
Additionally, equity products related to trading and
non-trading positions with notional amounts of $740
million and $582 million, respectively, were outstand-
ing at December 31, 2005 and 2004. These derivatives
generally do not qualify for hedge accounting.
As noted, market risk arises from the international
banking trading activities in foreign exchange (both
directly through daily exchange transactions as well as
through foreign exchange derivatives), interest rate
derivatives (primarily swaps), equity derivatives and
securities trading. Proprietary positions taken in foreign
exchange instruments, interest rate risk instruments and
the securities portfolios are monitored daily against
Value-at-Risk (VaR) limits. The VaR methodology used
to measure the daily exposure from trading activities is
calculated using a parametric technique using a
correlation matrix based upon historical data.
The VaR measure uses a 99 percent confidence interval
to estimate potential trading losses over a one-day
period. The average VaR for trading activities was less
than $1 million for both 2005 and 2004.
Operational Risk Management Process
The Company defines operational risk as the risk of not
achieving business objectives due to failed processes,
people or information systems, or from the external
environment (e.g., natural disasters). The Company rec-
ognizes that operational risk is inherent in all business
activities and can impact an organization through direct
or indirect financial loss, brand or reputational damage,
customer dissatisfaction, or legal or regulatory penalties.
The management of operational risk is an important
priority for the Company. To mitigate such operational
risks, the Company has developed a comprehensive
operational risk program that enables the identification,
measurement, monitoring and reporting of inherent and
emerging operational risks. During 2005, this program,
utilizing the same process risk self assessment method-
ology used to facilitate compliance with Section 404 of
the Sarbanes Oxley Act, has been extended to
non-financial operational risk self assessments. An
operational risk management reporting process that
provides business unit leaders with operational risk
information on a quarterly basis to help them assess the
overall operational risks of their business unit has also
been implemented. These initiatives have resulted in
improved operational risk intelligence and a heightened
level of preparedness to manage operational risk
events and conditions that may adversely impact the
Company’s operations.
The Company’s operational risk governance structure
includes an Operational Risk Management Committee,
which is responsible for maintaining the operational risk
framework and related policies and for overseeing the
implementation of the Company’s operational risk pro-
gram. The Committee is chaired by the Chief Opera-
tional Risk Officer and Vice Chairman of the ERMC and
has member representation from business units and
support groups. The business units have the responsi-
bility for implementing the framework as well as the
day-to-day management of operational risk, creating a
partnership that ensures close monitoring and increas-
ing awareness for operational risk.
Financial Review
AXP / AR.2005
[45 ]