RBS 2011 Annual Report Download - page 231

RBS Group 2011 229
Market risk
All the disclosures in this section (pages 229 to 235) are audited, unless
indicated otherwise with an asterisk (*).
Market risk arises from changes in interest rates, foreign currency, credit
spreads, equity prices and risk related factors such as market volatilities.
The Group manages market risk centrally within its trading and non-
trading portfolios through a comprehensive market risk management
framework. This control framework includes qualitative guidance in the
form of comprehensive policy statements, dealing authorities, limits
based on, but not limited to, value-at-risk (VaR), stress testing, positions
and sensitivity analyses.
Governance
Business structure
The primary focus of the Group’s trading activities is to provide an
extensive range of debt and equity financing, risk management and
investment services to its customers, including major corporations and
financial institutions around the world. The Group undertakes these
activities organised within the principal business lines: money markets,
rates flow trading, currencies and commodities, equities, credit markets
and portfolio management and origination.
Financial instruments held in the Group’s trading portfolios include, but
are not limited to: debt securities, loans, deposits, equities, securities sale
and repurchase agreements and derivative financial instruments.
The Group undertakes transactions in financial instruments that are
traded or cleared on an exchange, including interest rate swaps, futures
and options. Holders of exchange traded instruments provide margin on a
daily basis with cash or other security at the exchange.
The Group also undertakes transactions in financial instruments that are
traded over-the-counter (OTC) rather than on a recognised exchange.
These instruments range from commoditised transactions in derivative
markets, to trades where the specific terms are tailored to meet customer
requirements.
Assets and liabilities in the trading book are measured at their fair value.
Fair value is the amount at which the instrument could be exchanged in a
current transaction. The fair values are determined following IAS 39
guidance, which requires banks to use quoted market prices or, where
this is not possible, valuation techniques (models) that make appropriate
use of available observable inputs. When marking to market using a
model, the valuation methodologies are approved by all stakeholders
(trading, finance, market risk, model development and model review)
prior to use for profit and loss and risk management purposes. Any profits
or losses on the revaluation of positions are recognised in the daily profit
and loss.
Organisation structure
Independent oversight and support is provided to the business by the
Global Head of Market & Insurance Risk, assisted by the Group and
business Market Risk teams. The head of each business, assisted by a
business market risk management team, is accountable for all market
risks associated with its activities. The Global Market Risk Committee
reviews and makes recommendations concerning the market risk profile
across the Group, including risk appetite, risk policy, models,
methodology and market risk development issues. The committee meets
monthly and is chaired by the Global Head of Market & Insurance Risk.
Attendees include respective business market risk managers and Group
Market Risk.
Risk management
Key principles
The Group’s qualitative market risk appetite is set out in policy
statements, which outline the governance, responsibilities and
requirements surrounding the identification, measurement, analysis,
management and communication of market risk arising from the trading
and non-trading investment activities of the Group. All teams involved in
the management and control of market risk are required to fully comply
with the policy statements to ensure the Group is not exposed to market
risk beyond the qualitative and quantitative risk appetite. The control
framework covers the following principles:
xClearly defined responsibilities and authorities for the primary
groups involved in market risk management in the Group;
xAn independent market risk management process;
xAmarket risk measurement methodology that captures correlation
effects and allows aggregation of market risk across risk types,
markets and business lines;
xDaily monitoring, analysis and reporting of market risk exposures
against market risk limits;
xClearly defined limit structure and escalation process in the event of
amarket risk limit excess;
xUse of VaR as a measure of the one-day market risk exposure of all
trading positions;
xUse of non-VaR based limits and other controls;
xUse of stress testing and scenario analysis to support the market
risk measurement and risk management process by assessing how
portfolios and global business lines perform under extreme market
conditions;
xUse of back-testing as a diagnostic tool to assess the accuracy of
the VaR model and other risk management techniques;
xAdherence to the risks not in VaR (RNIV) framework to identify and
quantify risks not captured within the VaR model; and
xAnew product approval process that requires market risk teams to
assess and quantify market risk associated with proposed new
products.