Enterprise Risk Management with

Independent Derivatives Valuation:

Helping Banks Find Long-Term Success

WHITE PAPER

Enterprise Risk Management with Independent Derivatives Valuation

TABLE OF CONTENTS
Introduction ............................................................................................... 1
Building an Integrated Risk Infrastructure ............................................ 2
Key Requirements .............................................................................. 2
Key Components ................................................................................. 3
Data Management ........................................................................... 3
A Powerful Risk Engine ................................................................... 4
Independent and Transparent Valuations ........................................ 5
Reporting and Workflow Configuration ........................................... 6

A Joint Solution from Leading Vendors ................................................. 7

Enterprise Risk Management with Independent Derivatives Valuation

Introduction
Risk management today is top of mind for banking professionals around the
world, and it has begun to revolutionize the way banks operate. No longer is
risk management the sole responsibility of the chief risk officer or a banks risk
department; its responsibility now resides with vice presidents, associates,
directors and managing directors across various business units.
Banks have felt the pressure more than other financial institutions to improve
their risk management practices to avoid a repeat of the credit crisis. The need
for improved risk management is not only being driven by regulators, but by
internal and external stakeholders: investors, boards of directors and, in some
cases, governments. Compliance aside, implementing effective risk policies
that are designed to continuously manage a firms risk-and-return profile and
capital are required for the long-term success of a bank.
The recent distress in financial markets has placed greater emphasis on a
financial institutions ability to demonstrate a comprehensive approach to
viewing firmwide exposures and risk. A number of published papers1 point
to the deficiencies of many financial institutions risk management practices
and the concrete actions that need to be taken. The Institute of International
Finance report stated that a firms risk management approach should not rely
on a single risk methodology, but instead take a comprehensive approach,
integrating strands such as credit, market, operational, liquidity and reputational risks. Rating agencies are increasingly focusing on the quality of a firms
enterprise risk management practices in their rating processes. For example, in
2008, Standard & Poors announced that it will review the quality of enterprise
risk management as a new component in its reviews of credit ratings.
An additional area of focus for banks is the need to provide transparency in the
derivatives transactions and valuations that are being delivered. This change
requires banks to step away from their closed, black-box systems and move
toward third-party solutions offered by vendors especially those that include
comprehensive documentation of the models and methodologies used.
Financial models developed in-house no longer provide the required level of
transparency and independence needed to meet all stakeholder and regulatory
requirements. In a 2009 report, the analyst firm Celent stated that disclosure
and pricing or valuation methodologies were key starting points for restoring
confidence in the derivatives and structured finance markets.
Banks are now taking a closer look at how they price and value derivatives. They
are seeking better ways of assessing and measuring risk across the enterprise.
And more importantly, they are seeking ways to integrate the valuations of their
large and often disparate derivatives portfolios with an enterprise risk system
that can handle large volumes of data. To save time and money from in-house
development, banks look to best-of-breed, third-party solutions that can be
easily integrated, while providing the capabilities they need.

1 Senior Supervisors Group, 2008; Financial

Stability Forum, 2008; Institute of International
Finance, 2008; and Basel Committee, June
and August 2008, and January 2009.

Enterprise Risk Management with Independent Derivatives Valuation

Building an Integrated Risk Infrastructure

SAS, the leader in enterprise risk management solutions,2 and FINCAD, a
leading provider of derivatives analytics, have partnered together to offer a
joint solution that will give firms:

Comprehensive risk capabilities covering the spectrum of market, credit,

operational and firmwide risk.

Access to one of the broadest cross-asset class derivatives and fixed

income analytics library that uses industry-standard models.

Full disclosure of the data, models, analytics and risk measures used.

Assurance knowing they are working with proven and accepted solutions
from two vendors that are leaders in their respective fields.

SAS supports financial institutions risk management activities by delivering

functionality for all major risk types, as well as data management and reporting.
It is important that the risk management solution allows business units to
independently and separately calculate measures of risk, such as market,
credit and ALM, as well as calculate firmwide risk measures using models
and correlated aggregation techniques.
FINCAD provides financial institutions with independent valuations of their
securities portfolios for all major asset classes, including interest rate, foreign
exchange, commodity, credit and equity derivatives, mortgage-backed
securities, fixed income securities and structured products.

Key Requirements
The challenges faced by financial institutions demand these key requirements:

A quality integrated risk data infrastructure with timely access to data.

The ability to measure exposures and risks across all risk types and books
of business for better control.

The ability to distribute incentives for consistent optimization of riskadjusted returns throughout the organization.

SAS meets these requirements through an architecture that supports the

data requirements, methodology requirements, usability criteria and ability to
distribute key risk information effectively across the enterprise for many different
users. SAS provides functionality that allows users to integrate FINCADs
derivatives analytics library directly into the system for analysis.
A key requirement of a risk management system is the ability to support several
different risk application streams within one common environment. Business
units need specific risk calculations and monitoring capabilities. At the higher
levels of the organization, these risks will need to be integrated and aggregated
to create firmwide measures.

2 SAS was ranked number-one in Chartis

Researchs prestigious RiskTech100 2009
rankings, an annual international listing of the
top risk technology vendors.

Enterprise Risk Management with Independent Derivatives Valuation

The integrated SAS solution, SAS Risk Management for Banking, covers the
four main risk areas:

Market risk.

Credit risk.

Asset and liability management.

Firmwide risk.

The applications are based on a common data model with predefined extraction,
transformation and loading (ETL), risk analytics and risk reporting. The integrated
risk applications in SAS Risk Management for Banking enable users to get up
and running quickly, while the open infrastructure of the solution allows users to
support not only current business requirements, but also future requirements on
data and risk analytics.

Key Components
The key components for building an integrated risk infrastructure include:

Data management.

A powerful risk engine.

Independent and transparent valuations.

Reporting and workflow configuration.

Data Management
Regulators have pointed to incomplete, inconsistent and unreliable data as
contributing to the financial crisis, and continuing inadequacies in this area are
a major obstacle to more robust and efficient markets. Disparate data sources
form an often overwhelming hurdle for anyone involved in the implementation of
an ERM solution. Analyst firm TowerGroup3 stated that more than 50 percent
of the effort in implementing an enterprisewide risk management system is
feeding data.
Challenges include everything from the sheer number of sources to ensuring
the integrity of the staged data. The process of systematically organizing
information to support an enterprise risk initiative is fundamental to ensuring
good risk management practices. A well-designed approach to managing
risk information is a critical component of a best-practice risk management
program. However, high-quality risk information management programs continue
to elude many organizations, and inferior information quality adversely affects
risk management. It is important for organizations to understand not only how
to assess the integrity of their risk data but also to know how to address this
problem in a cost-efficient manner. Analysis of risk data availability and integrity
needs to be addressed in a continuous, structured, methodical way, with
measurements in place to feed analytics just like any other operational risk.

3 Guillermo Kopp, Managing Systemic Risk:

A New Era for Financial Services
(TowerGroup: April 9, 2009).

Enterprise Risk Management with Independent Derivatives Valuation

Profile, monitor and actively manage the quality of enterprise risk data:
oo

Analyze and assess the reliability, accuracy and general state of

data across the risk management spectrum to determine where
potential problems exist and what efforts will be required to rectify
them BEFORE projects start.

oo

Focus on root-cause analysis to improve key risk data areas and

processes for better planning and project execution.

Integrate and standardize risk data from multiple systems and business
units into a unified, accurate view:
oo

Implement both standardized and customized risk data processes

across the enterprise with consistent business rules.

oo

Adopt consistent data quality business rules across risk and other
data sources and platforms.

Ensure regulatory compliance with state-of-the-art data quality technologies

that enable business and technical users to cleanse, standardize, integrate,
match and augment risk data using a specialized interface and state-ofthe-art data quality tools that can be customized to meet organizational
requirements:
oo

Define risk data correction rules to reflect organizational changes

and adjust data where needed.

oo

Visualize the impact of business rules and data cleansing efforts.

Provide decision makers with trustworthy information for managing risk:

oo

Automatically incorporate consistency, accuracy and business rule

checks on your data into your risk processes or infrastructure.

oo

Deliver consistent information. Reports and reliable analytic results

are based on risk data that is both accurate and current.

Organizations are becoming keenly aware of the ramifications of unreliable,

inconsistent poor data: dissatisfied customers, confused employees, unhappy
stakeholders and poor bottom-line results.

A Powerful Risk Engine

SAS Risk Dimensions is the powerful and versatile risk engine underlying
the analytical functionality of SAS Risk Management for Banking. The SAS
risk engine supports a wide range of risk analysis methods and is the preferred
solution for the quantitative risk analyst and model builder. While SAS Risk
Management for Banking has both standard and advanced risk analyses
preconfigured, as well as pricing in the risk engine, the risk engine is also
designed to support a flexible development framework. This flexible development framework includes the ability to configure proprietary risk factor models,
as well as user-defined and external pricing libraries and cash flow models.

Enterprise Risk Management with Independent Derivatives Valuation

Independent and Transparent Valuations

FINCADs analytics library feeds into the SAS risk engine, providing independent
valuations of a wide range of derivatives and fixed income securities. Independent valuation is a key requirement in todays marketplace. Recent regulatory
changes and the need to ensure long-term viability are driving the demand.
Leveraging third-party solutions like FINCAD Analytics can greatly benefit a
financial institution by offering cost efficiency, scalability and flexibility. FINCAD
is a derivatives analytics specialist that is focused exclusively on keeping its
analytics solutions current with the changing world of analytic finance.
An implementation of any system is not an easy task. Likewise, the need for
an analytics vendor requires an examination of your current and future needs.
Selecting a vendor that offers cross-asset class analytics and a proven track
record is ideal. FINCAD Analytics coverage is extensive and wide-ranging,
covering all major asset classes:
Asset Class

Instrument Range

Interest Rates

From vanilla swaps to CMS spread

swaptions.

Foreign Exchange

From European options to power

reverse dual currency (PRDC) notes.

Credit

From single asset CDS to complex

collateralized debt obligations (CDOs).

Fixed Income

From noncallable government debt to

range accrual notes.

Equity

From warrants to callable/puttable

convertible bonds.

Commodity

From index options to commodity

swaps.

Mortgage-Backed Securities

From fixed-rate passthroughs to

collateralized mortgage obligations.

Volatility

From volatility swaps to conditional

variance swaps.

To support the hundreds of instrument types a bank may have in its portfolio,
both simple and complex models are required. FINCAD Analytics uses a variety
of models including, but not limited to:

Black and Black-Scholes.

Various stochastic volatility (Heston and SABR).

LIBOR Market Model.

Gaussian copula.

FINCAD Analytics is a dynamic derivatives library that keeps pace with the
changing derivatives market. Additional instrument coverage, new models
and new asset classes get added to the library as the market evolves. FINCAD
recently included the ISDA CDS model in its latest release of the analytics library.

Enterprise Risk Management with Independent Derivatives Valuation

To help mitigate systemic risk, financial institutions are moving toward best
practices that incorporate more transparent processes for derivatives valuations.
Black-box solutions are no longer acceptable from a transparency and risk
control perspective. Financial institutions are being asked to disclose all the
facts about their derivatives transactions:

What are the models and methods used to value derivatives?

How accurate are the inputs to the valuations?

What risks are involved and how are they measured?

Who are the counterparties involved and what is their level of risk?

All FINCAD solutions contain comprehensive documentation where every

model, calculation methodology and reference is fully documented, providing
the transparency needed to understand how the models work and how they
are implemented. FINCAD documentation is granular to the point that it shows
the mathematics behind the functions used to value instruments and also
how the curves are constructed. Instead of proprietary models, FINCAD uses
industry standard analytics models that are published and in the public domain
giving organizations access to published papers discussing the model, its
uses and limitations. The valuations provided by FINCAD Analytics are fed into
the SAS risk engine for further risk analysis.

Reporting and Workflow Configuration

SAS Risk Management for Banking is part of the SAS Business Analytics
Framework, which combines advanced data integration, analytics and reporting
capabilities. With this framework, users get the information they need, when
they need it, in their preferred format. The SAS Business Analytics Framework
also offers a robust and flexible presentation layer for the full breadth of SAS
Analytics capabilities all integrated within a business context for better, faster
decision making. Using SAS Stored Processes, users can configure their own
workflows and integrate daily and ad hoc, advanced risk analytics procedures
into their preferred environments (e.g., using the SAS Add-In for Microsoft
Office, users can integrate their reporting and analysis workflows into their
desktop environments).
SAS Risk Management for Banking comes with a wide array of preconfigured
reporting and risk analysis workflows. The report framework includes sample
reports, OLAP cubes and interactive analysis results for all the application
components of SAS Risk Management for Banking.
As the bank creates risk measures, employees may quickly find that bringing
risk information together to support enterprisewide reporting is also very
challenging. To meet this challenge, SAS Risk Management for Banking
provides a common reporting data model. This data model the SAS Risk
Reporting Repository supports the integration and reporting of enterprise
risk measures as well as decomposed measures at the entity, business unit,
geography or any other user-defined hierarchy level. This repository provides
the audit, change, archive and historization support required by rigorous

Enterprise Risk Management with Independent Derivatives Valuation

reporting requirements. The SAS Risk Reporting Repository allows the bank
to meet both current and future reporting requirements, while exploiting the
power of the SAS Business Analytics Framework.

A Joint Solution from Leading Vendors

As banks increasingly look to best-of-breed, third-party solutions for their risk
management and independent derivatives valuation needs, SAS and FINCAD
have partnered to offer a joint solution to address these needs. Following this
best-of-breed approach can save a bank significant time and costs over
developing the systems in-house.
SAS is the leader in business analytics software and services, and the largest
independent vendor in the business intelligence market. Through innovative
solutions delivered within an integrated framework, SAS helps customers at
more than 45,000 sites improve performance and deliver value by making
better decisions faster. SAS comprehensive risk offerings are built on the SAS
Business Analytics Framework, a powerful blend of data integration, analytics
and reporting capabilities. This leading position was recognized in Chartis
2009 RiskTech100 report, where SAS received the No. 1 overall position.
FINCAD has been providing software and services supporting the valuation and
risk management of cross-asset class derivatives and fixed income securities
for close to 20 years. FINCAD solutions are used by more than 35,000 financial
professionals in over 80 countries and have become the industry standard for
financial analytics. FINCAD was recognized as a leading vendor in Celents
2009 report, Pricing Solutions for OTC Derivatives and Structured Products.

FINCAD
Phone: +1 604 957 1200
Toll-Free: 1 800 304 0702
(USA/Canada only)
www.fincad.com

The joint solution from SAS and FINCAD is an enterprise risk management
system with independent derivatives valuations. The joint solution has already
been successfully implemented at leading financial institutions, including one
of the top 10 largest banks in the US. If your organization is interested in
learning more about the joint solution, contact a representative from FINCAD
or SAS today.

SAS Institute Inc.

World Headquarters +1 919 677 8000
To contact your local SAS office,
please visit:
www.sas.com/offices

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