CVaR Mean Conditional Value At Risk

CVaR is a variant of VaR,  Variance at Risk.

History

VaR was developed by JPMorgan risk group in the early 1990s. Most of that risk group left to start a consultancy to sell the risk management calculation to other banks. It was originally developed because the executives at JPMorgan wants a simple way to wrap up all of the risk into a single number. VaR is the amount in dollars that the institution is expected to lose before trading begins the following day, and therefore required to borrow overnight. The calculation was inserted into a report called the 4:15 Report, which was a report that came up at, you guessed it, 4:15 PM, or fifteen minutes after each trading day. The tool became very effective and useful, so much so that Basel II Accord incorporated it.

CVaR is nothing more than taking the various risk variables and then weighting them for what a risk manager believes is a more accurate view of the market risk. Obviously this has some subjectivity to it. The idea is that VaR doesn’t weigh risks from, say, lending equities differently from trading on the bank’s books.

Controversy

There has been a long running controversy over VaR, and therefore CVaR. VaR is a probability calculation and therefore it doesn’t tell its reader how much the firm could lose. It tells the reader how much the firm will likely lose. The qualitative difference between the statements is the former is a definitive number while the latter is a forecast. The former is accurate and the latter is prediction, which is inherently inaccurate. The quantitative difference is $0 and infinity. Since VaR is used to either insure against losses through borrowing or hedging, it is merely spreading the risk of loss and therefore, making the whole capital markets system bear the risk of a firm. The benefit is that because it is probability-based, it is very good when the markets are normal. VaR opponents says there is no such thing as normal.

Opinion

Both sides are right. VaR is an effective tool to manage risks that stem from business-as-usual. But management rely heavily on it, and the system gradually build up risks for firms and eventually implodes. And it is a poor way to forecast extraordinary large risks, also known as tail risk. As a matter of fact, it is specifically designed to truncate the tail risk so that it can arrive at a dollar figure. One way to think about how this cannot work in all situations is to think about shorting a stock. If you buy a share of XYZ for $10, the most you can lose is $10 because the value of the shares cannot go below $0 and shareholders are not liable for debts beyond the the value of equity and assets. But if you short XYZ, it means you lose money every time XYZ’s price goes up. Well, there is no upper limit to how high the stock price can go. This is the reason why, as long as a bank holds shorts of any sort, it can lose infinite amount of money. Not likely, but possibly.

So, while both sides are right, only the side in favor is wrong. Easy to say, but hard to swallow if you are managing a bank and you need some way to reduce market risk for your bank. VaR is a very useful tool.


About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses. He is the author of the forthcoming book History of Money Laundering: How criminals got paid and got away.


Managing Regulatory Risk

On Monday, January 26, Associations of Certified Anti-Money Laundering Specialists (hereon ACAMS) held its Third Annual AML Risk Management Conference at The Conrad Hotel in downtown New York. Over the course of this week, summaries and takeaways from the key notes and panel discussions will be shared in this blog.

  • John Byrne, Moderator, Former President of Condor Consulting LLC
  • Jamal El-Hindi, Associate Director, Policy Division, Financial Crimes Enforcement Network (FinCEN), US Department of the Treasury
  • Sarah Green, Senior Director, AML Compliance, Financial Industry Regulatory Authority (FINRA)
  • Denise Reilly, Managing Director, Global Head of BSA/AML Compliance, Citibank
  • James Vivenzio, Senior Counsel for BSA/AML, Office of the Comptroller of the Currency (OCC)

HeaderThis panel discussion covered topics ranging from expectations from regulators, culture of compliance in a firm, and personal liability. The following are  ten takeaways:

  1. Enterprise-wide consistency helps to mange the professionals and reduce gap risk.
  2. Regulators like to see consistency because it shows the effort an institution is putting into trying to be compliant.
  3. Communicate to Boards of Directors that OCC would like to see more focus on compliance from them
  4. Alert Suppression is okay and critical to executing priorities, but the alerts should be logged and revisited to keep the compliance programs up-to-date with the changing environment both ex-firm and intra-firm.
  5. Personal Liability of compliance officers will increase, so, keep good documentation
  6. FINRA does not target individuals, though individuals will face penalties if found willfully unaware or intentionally non-compliant. FINRA focuses on systemic risks to protect investors.
  7. FinCEN does not target individuals, especially trying to avoid dissuading the most talented compliance professionals from fleeing the most difficult problems.
  8. Intra-firm talent development is key to today’s labor market where supply of veteran compliance officers are small compared to demand.
  9. OCC intends to staff lead experts on all exams in the future.
  10. The new OCC Exam Manual, published November 11, 2014, does not have much substantive changes, mostly it is an administrative update to make sure changes to exams since the last major update are documented.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.
He tweets @MoneyCompliance

 

Adam Szubin’s Key Note

On Monday, January 26, Associations of Certified Anti-Money Laundering Specialists (hereon ACAMS) held its Third Annual AML Risk Management Conference at The Conrad Hotel in downtown New York. Over the course of this week, summaries and takeaways from the key notes and panel discussions will be shared in this blog.

Adam Szubin is the exiting director of Office of Foreign Assets Control (OFAC) in the Department of Treasury. Soon, he will be the acting under secretary for Terrorism and Financial Intelligence, another office in the Treasury.

HeaderSzubin has a history of speaking at Financial Crimes-related conferences because of his long held position as the director of OFAC. Applauded members of ACAMS for doing their best to make Anti-Money Laundering profession a serious endeavor. Then he alerted to three nuanced risks for the profession.

CUBA was his first concern. As the United States lifts nearly all of its sanctions against the communist island nation this year, it opens up another route for corruption to take place.

RUSSIA was his second concern. OFAC’s Magnitsky Sanctions List enumerates targets explicitly, but not all activities are sanctioned and not all enumerated have been sanctioned the in the same manner. The theme of this sanction is debt and equity financing, or the limit thereof. This is a target on a crucial source of currency for Russia in order for it to succeed. The capital markets have also worked against Russia by lowering the price of oil, the primary source of revenue for Russia. It’s an additional wind behind OFAC’s sanctions.

IRAN was his final enumerated concerns. Even more nuanced than the previous two examples. Iran’s domestic politics indicate the type and length to which the regime is willing to evade western powers to fund terror.

Transparency is the key to successful sanctions compliance. Breach of compliance is often accidental. Finding breaches are difficult because often the breaches are in omnibus accounts. Also global trade cannot stop for complex business areas, like re-insurance of trans-ocean ships.

Because of the human nature of business, financial crimes will occur in some form or another. Professionals Certified Anti-Money Laundering Specialists greatly reduce the efficacy of criminal activities.


About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.
He tweets @MoneyCompliance