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Risk Appetite: A new Menu under Basel 3?
Zanders Seminar “Effectief Kapitaalmanagement”

Pieter Klaassen
UBS - Firm-wide Risk Control & Methodology




1 November 2012
Agenda

 What is this “Risk Appetite”?
 UBS Firm-wide Risk Appetite Framework
 Basel 3: A Stricter Diet
 Risk Appetite under Basel 3




                                          1
Section 1


What is this “Risk Appetite”?
What is this “Risk Appetite”?

 Risk Appetite
    “The level and type of risk a firm is able and willing to assume in its exposures and business
    activities, given its business objectives and obligations to stakeholders.”
    “Risk appetite is generally expressed through both quantitative and qualitative means and should
    consider extreme conditions, events, and outcomes. In addition, risk appetite should reflect
    potential impact on earnings, capital, and funding/liquidity.”
    (Senior Supervisors Group, “Observations on Developments in Risk Appetite Frameworks and IT
    Infrastructure”, December 23, 2010)

 Context
    – Papers by the Senior Supervisors Group (SSG) and Institute for International Finance (IIF)
      established that a comprehensive firm-wide risk appetite framework covering all types of
      risks is now considered essential and not just best practice
    – Basel II, Pillar 2:
      “The bank’s board of directors has responsibility for setting the bank’s tolerance for risks. It
      should also ensure that management establishes a framework for assessing the various risks,
      develops a system to relate risk to the bank’s capital level…“



                                                                                                         3
Risk Appetite: Key Elements
Regulatory Expectations and Industry Best Practices

 Comprehensive approach – integrating credit, market, operational, liquidity, and
  reputational risks across the firm
  – Both quantitative and qualitative elements

 Use of multiple methodologies (taking into account technical limitations of risk metrics,
  models, and techniques such as VaR) – incorporating, in particular, stress/scenario
  testing and consideration of risk concentrations
 Translate risk appetite at the top of the house to risk appetite (limits) for individual risk
  types and at lower levels of the organization (business units and below)
 Link to strategic planning and budgeting process - collaboration among risk
  management, finance, and strategy functions
 Role of risk culture, ‘tone from the top’


              Risk appetite as a continuous, evolutionary, learning process – not
              just a one-time exercise


                                                                                                  4
Defining, Challenging and Monitoring Risk Appetite
Firms’ management, boards, risk management departments, and supervisors all
have roles
 Management should articulate the firm’s appetite for risk in the context of business
  strategy
  – They own the risk and are expected to fully understand the firm’s risk position at all times

 Boards should
  – set basic goals for the firm’s risk appetite and strategy,
  – review and affirm management’s articulation of risk appetite, and
  – ensure that risks are comprehensively considered and managed

 CROs should (and should be empowered to):
  – assess and control the firm-wide risk level
  – provide an integrated view of the overall risks the firm faces, and
  – ascertain that the firm’s risk level is consistent with its risk appetite

 Supervisors have a role in assessing and challenging Boards’ and Managements’
  achievement of these goals, risk awareness and understanding, and conformance to
  (evolving) best practice


                                                                                                   5
Section 2


UBS Firm-wide Risk Appetite Framework
Earnings/Capital Waterfall Continuum – at Least in Principle
                        Capital Criteria                     Earnings Criteria
                   Solvency

                      Regulatory Constraints
        View



                                  Rating Change

                                                    Positive Earnings, Payment of Dividends

                                           Risk Exposure:                   Mean Earnings
                                           Deviation from Mean Earnings at:
        Risk




                                                                                                    Probability
                              99.9+%
                                                          95%




                                       0
      Cushion
      Capacity /




                                                                                              Earnings

                        Capital        Dividend      Earnings Power/Capacity
        Event




                                        Earnings/Dividend
                   Capital Depletion
                                        reduction
                                                                                                                  7
Evolution of Risk Appetite & Experience during the Crisis
Shift to ensuring going concern under stress

Traditionally, focus on:
 Solvency perspective
  – Consideration of Economic Capital and total (or Tier 1) capital

 Dividend paying ability in most years, also in adverse economic situation


Experience during the crisis:
 Focus on going-concern capital metrics (e.g., Tier 1 ratio)
  – Loss-absorbing capital is what matters

 Consider scenario-based stress metrics in addition to statistical metrics
  – Look beyond historical experience

 Ensure stable funding sources and ample liquid assets



                                                                              8
Implications for Risk Appetite
Embedding multiple complementary criteria

 Need for complementary criteria (with different time horizons and confidence/severity
  levels), representing different points in the financial structure/stakeholder waterfall. E.g.:
  – Traditional EC view at a high (99.9+%) confidence level over 1 year and/or multiple years
  – Tier 1 ratio or similar view at a lower confidence level over ranges from 1 quarter to multiple
    years
  – Earnings view at a lower (one in 5-25 year) confidence level over 1 quarter to 1 year time horizon

 Focus on high-quality equity capital (convergence to Basel III or similar view)




                                          Multiple severity levels, metrics, and risk horizons


                                                                                                      9
UBS Firm-wide Risk Appetite
Pillars



                              UBS Risk Appetite Framework

                                      Minimum Tier-1
            Earnings                      Capital                Solvency

          Earnings should               Loss-absorbing         Ensure sufficient
            cover the risk            capital is sufficient        total loss-
             of losses in                      to              absorbing capital
             most years                 meet regulatory       to sustain even an
                   +                  requirements even         extreme stress
           Avoid repeated               if a severe loss             event
          (large) quarterly              event were to
                losses                        occur

   Stress             Stress        Stress          Stress        Stress
  Statistical        Scenario      Statistical     Scenario      Statistical

                                                                                   10
Risk Appetite objectives: Risk Capacity vs Risk Exposure

                                                }   Buffer
                                                                      Taking into account
                                                                   strategic considerations



                  Earnings
                                                             Credit Risk

                                                             Market Risk
                   Capital




                                                                                    Risk Appetite
                                                             Issuer Risk

                                                        Investment Risk
        Regulatory requirements                           Funding Risk
            and constraints
                                                          Country Risk

                                                          Pension Risk

                                                        Operational Risk


                 Risk Capacity                          Risk Exposure
        maximum amount of risk a firm is        the amount of risk, by whatever
       technically able to assume given its     metric, actually being taken at a
         capital base, liquidity, borrowing   point in time, or expected/forecast to                11
       capacity, and regulatory constraints                  be taken
Overview of Firm-wide Risk Appetite Framework
   The framework encompasses all material risk categories, and plays a key role in the decision-
   making processes in the Bank

                                                 Firm-wide Risk Appetite Framework


Risk Capacity      Risk Exposure
 Business
  Plans
                                                   E@R / C@R                    Exposure        Firm-wide
  (projected net                                                                                  Stress
                                                                                Measures
  earnings and
  capital)                                                   Statistical                                Stress
                        Risk Categories                      Measures                                   Measures
less
 Business Risk     Operational                                                    Credit                 Country   Investment   Pension
                       Risk
                                  Funding Risk     Market Risk    Issuer Risk                 LU Risk
  (volatility in                                                                    Risk                   Risk         Risk       Risk
  earnings)
                      Consequential Risks                                           Position Risks

                   Granular Limit Framework
                                       The firm-wide statistical and stress metrics are complemented with
                                           a granular limit framework with portfolio and position limits



                   Of the various scenarios in the Firm-wide Stress framework, the most relevant /
                   severe one is used as the ‘binding’ scenario in the Risk Appetite Framework
                                                                                                                                           12
Risk Exposure: Firm-wide measures
UBS has two complementary approaches – one statistical and one stress based



                     Statistical measure which allows the aggregation of firm-wide risks using
Earnings-at-Risk /   statistical techniques which can then be tied to probabilities / confidence
 Capital-at-Risk     levels
  (E@R / C@R)
                     A large number of potential outcomes and associated losses is simulated,
                     rooted in historically observed market changes



                     More intuitive stress measure which calculates the impact of a scenario on
Firm-wide Scenario   the firm-wide portfolio including the causality chain by which losses would
    Stress Test      arise if the scenario were to unfold
                     Scenarios enable incorporation of forward-looking views



  Under both firm-wide measurement approaches, we model the first order P&L and capital
  impacts as well as the consequential capital impacts of downgrades in the Firm's portfolio
  and resulting adjustments to RWA


                                                                                                   13
UBS Approach for Firm-wide Stress Testing
Scenario-based stress tests

                             Risk Factor
                                                          P&L impacts
                             Sensitivities
  Macro-economic
                               and/or                     OCI impacts            Aggregation
     scenario
                             Revaluation
                                                          RWA impacts
                            methodologies


Various global       Quantitative and            Credit Risk      Quarterly time profile of
downturn scenarios   qualitative analysis of                      • P&L (losses, earnings)
                     historical data about       Market Risk
                                                                  • OCI impacts
                     defaults,                   Issuer Risk      • Risk Weighted Assets
                     impairments, write-
                     downs etc.                Investment Risk    and ultimately Tier 1 capital
                                                                  ratio
                                                Funding Risk

                                               Operational Risk    Tier 1 Capital Ratio

                                                Pension Risk                                              Critical
                                                                                                          threshold
                                                Country Risk

                                                Business Risk
                                                                  Q1   Q2   Q3   Q4   Q5   Q6   Q7   Q8
                                                                                                            14
UBS Statistical Risk framework
Comprehensive assessment of risks

Position Risks             Consequential Risks         Business Risks
                                                                               =         Aggregate
                                                                                         Statistical Risk
    Market                 Operational                    Business                         Exposure

    Issuer                   Funding
                                                         Targeted stress                    Expecte




                                                                                                            Probability
    Credit                   Pension                      components                           d
                                                                                            Earnings
   Country
                                                     Capture special risks
                                                     not modeled statistically                 0
  Investment                                                                                           Earnings

     Step One                   Step Two                   Step Three
                                                                                        = Copula Aggregation



 Aggregate Group Risk Exposure derived from probability distribution of potential earnings shortfalls,
  supplemented by targeted stress components.
 Diversification between risk types is included at each aggregation step



                                                                                                                          15
Section 3


Basel 3: A Stricter Diet
Too-Big-To-Fail




                  Sylvan Wegmann

                                   17
Basel 3: Increased Minimum Capital Requirements


Following Basel Committee …                                                                                                                      … and with “Swiss Finish”

              BIS Basel 3 Phase-in - Minimum capital requirement                                                    FINMA Basel 3 Phase-in - Minimum capital requirement
                              Global Systemically important Banks (G-SIB)                                             Systemically important Banks (maximum 6% progressive component)
 20%                                                                                                         20%

 18%                                                                                                         18%

 16%                                                                                                         16%                                                                                            6.00%
                                                                                                                                                                                             5.63%

 14%                                                                                                         14%                                                               5.12%

                                                                                                                                                              4.50%
 12%                                                                                             2.5%
                                                                                                             12%
                                                                                                                                                 3.75%                                                      3.00%
                                                                                1.875%                                                                                                       3.00%
 10%                                                                                                         10%                                                              2.875%
                                                                     1.25%                                                          2.75%
                                                                                                 2.0%                                                         2.625%
                                                          0.625%                  2.0%
                                                                                                                                                 2.25%
 8%                                                                  2.0%                                    8%
                                                              2.0%                               1.5%                1.50%          1.75%
                                                                                  1.5%                                                                                                                      5.50%
                             2.5%           2.0%                                                                                                                                             4.88%
                                                                     1.5%                                            1.00%                                                     4.25%
              3.5%                                                                                           6%                                               3.63%
 6%                                                           1.5%                               2.5%                                            2.88%
                                            1.5%                                1.875%                                              2.75%
                                                                     1.25%
                             1.5%                         0.625%                                                     2.50%
 4%           1.0%                                                                                           4%

 2%                          4.0%           4.5%              4.5%   4.5%         4.5%           4.5%        2%                     4.00%        4.50%        4.50%            4.50%         4.50%          4.50%
              3.5%                                                                                                   3.50%

 0%                                                                                                          0%
              2013           2014           2015              2016   2017        2018        Basel 3- Full           2013           2014         2015         2016             2017          2018       Basel 3- Full

       G-SIB additional capital (max)        Tier-2 Capital                  Additional Tier-1 Capital             Progressive component (CoCos 5% trigger)            Capital Buffer - CoCos 7% Trigger (max)
       Capital Conservation Buffer (CET1)    Minimum CET1                                                          Capital Buffer - CET1 (min)                        Minimum CET1




                                                   Excludes Countercyclical Capital Buffer (max 2.5%)

                                                                                                                                                                                                                        18
Basel 3: Lower Eligible Capital + higher RWA
                                          AV Corr        +1.4%



                                           CVA           +9.3%




                                        RWA vs           +7.6%
               Eligible Capital        deductions
                    -16.4%

                                         RWA
       -5.0%         DTA
                                        + 18.4%

       -3.6%      Inv. in Fin
                 Institutions
       -2.0%   Items > 15% CET1

                   Other
       -5.8%                      Source: EBA Basel III monitoring exercise,
                 deductions
                                  average of Group 1 banks, Sept 2012          19
In addition to impact of Basel 2.5
Stress VaR, IRC, CRM, and modified securitisation treatment




                                            increase UBS market risk RWA by 400%
           Source: UBS 3Q12 Report                                            20
Basel 3: UBS RWA Targets




       Source: UBS 3Q12 Results Presentation   21
Basel 3: New items on the menu



                                         Liquidity
                                         Coverage

          Leverage                         Ratio

           Ratio




                            Net Stable
                            Funding
                                 Ratio


                                                     22
Basel 3: UBS Balance Sheet Development
Influences Leverage Ratio capital requirement




                                       Target reduction of Assets excl PRVs to 600bn in 2015
           Source: UBS 4Q11 & 3Q12 Results Presentation                                   23
Section 4


Risk Appetite under Basel 3
Basel 3 is estimated to lead to increased product costs




      Source: “Basel III and European banking: Its impact, how banks might respond, and the challenges of
                                                                                                            25
      implementation”. McKinsey & Company, Working Papers on Risk 26, November 2010.
Basel 3: Capital Market Businesses are most affected
Structured credit, rates, and equity most affected; FX and cash equities least




                                                                                                      Mitigating
                                                                                                      actions:

                                                                                                       Portfolio
                                                                                                        optimization
                                                                                                       Model
                                                                                                        refinements +
                                                                                                        data quality
                                                                                                        improvements
                                                                                                       Conserving
                                                                                                        capital, liquidity
                                                                                                        and funding
                                                                                                       Operational
                                                                                                        enhancements


           Source: “Day of reckoning? New regulation and its impact on capital-markets businesses”,
           McKinsey & Company, Working Papers on Risk 29, October 2011.                                                      26
Basel 3: Considerations for Earnings Objectives
Focus on profitability of Core Businesses

 Original objective (2003) was to ensure minimum dividend payment
  – Even in adverse situation, with high probability

 Since the 2007-2008 financial crisis
  – Profits have been used to increase tangible equity instead of paying dividends
  – Risk taking has reduced substantially
  – Inventory of legacy exposures have been wound down
  – Market circumstances have been challenging

 Focus on profitability instead of paying dividends
  – For Core Businesses - Legacy exposures supported by capital
  – Differentiated tolerance for losses in different businesses




                                            New balance to be found between risk and return


                                                                                          27
Basel 3: Choices for Capital Objectives
Sufficient capital to ensure going-concern after severe stress


 Consider Basel 3 CET1 phase-in or fully-applied?
  – Regulatory capital based on phase-in
  – Analyst focus often already on fully-applied

 What minimum CET1 ratio to choose under stress for Tier-1 Capital objectives?
  – Impairment of capital buffer requires plan to replenish the buffer
  – Impairment of capital buffer can lead to restrictions on shareholder distributions and discretionary
    pay – up to imposing measures to increase capital and/or reduce RWA
  – Latest point at which FINMA interferes is 8.75% CET1 ratio
    – 50% impairment of capital buffer
    – Well before triggering high-trigger (7%) CoCos

 Maintain Solvency objective
  – Loss-absorbing capital as Risk Capacity

 Alignment with Recovery and Resolution plans



                                                                                                       28
Potential Extensions of Risk Appetite objectives

 Leverage ratio objective
  – Satisfying minimum leverage ratio also after a stress event?
    – FINMA leverage ratio denominator calculation (“assets”) to be finalized
    – Minimum leverage ratio requirement to be reviewed

 Establish connection with liquidity framework
  – Minimum liquidity and funding requirements after a stress event
  – UBS satisfies existing interpretation of LCR and NSFR

 Separate (but aligned) objectives for major legal entities
 Cascade Risk Appetite objectives to Business Divisions
  – Continue to do so through limit framework
  – In addition, consideration of business-specific objectives



                        Balance between comprehensiveness, simplicity & transparency


                                                                                   29

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Risk Appetite: A new Menu under Basel 3? Pieter Klaassen (UBS) voor het Zanders Risicomanagement Seminar 2012

  • 1. Risk Appetite: A new Menu under Basel 3? Zanders Seminar “Effectief Kapitaalmanagement” Pieter Klaassen UBS - Firm-wide Risk Control & Methodology 1 November 2012
  • 2. Agenda  What is this “Risk Appetite”?  UBS Firm-wide Risk Appetite Framework  Basel 3: A Stricter Diet  Risk Appetite under Basel 3 1
  • 3. Section 1 What is this “Risk Appetite”?
  • 4. What is this “Risk Appetite”?  Risk Appetite “The level and type of risk a firm is able and willing to assume in its exposures and business activities, given its business objectives and obligations to stakeholders.” “Risk appetite is generally expressed through both quantitative and qualitative means and should consider extreme conditions, events, and outcomes. In addition, risk appetite should reflect potential impact on earnings, capital, and funding/liquidity.” (Senior Supervisors Group, “Observations on Developments in Risk Appetite Frameworks and IT Infrastructure”, December 23, 2010)  Context – Papers by the Senior Supervisors Group (SSG) and Institute for International Finance (IIF) established that a comprehensive firm-wide risk appetite framework covering all types of risks is now considered essential and not just best practice – Basel II, Pillar 2: “The bank’s board of directors has responsibility for setting the bank’s tolerance for risks. It should also ensure that management establishes a framework for assessing the various risks, develops a system to relate risk to the bank’s capital level…“ 3
  • 5. Risk Appetite: Key Elements Regulatory Expectations and Industry Best Practices  Comprehensive approach – integrating credit, market, operational, liquidity, and reputational risks across the firm – Both quantitative and qualitative elements  Use of multiple methodologies (taking into account technical limitations of risk metrics, models, and techniques such as VaR) – incorporating, in particular, stress/scenario testing and consideration of risk concentrations  Translate risk appetite at the top of the house to risk appetite (limits) for individual risk types and at lower levels of the organization (business units and below)  Link to strategic planning and budgeting process - collaboration among risk management, finance, and strategy functions  Role of risk culture, ‘tone from the top’ Risk appetite as a continuous, evolutionary, learning process – not just a one-time exercise 4
  • 6. Defining, Challenging and Monitoring Risk Appetite Firms’ management, boards, risk management departments, and supervisors all have roles  Management should articulate the firm’s appetite for risk in the context of business strategy – They own the risk and are expected to fully understand the firm’s risk position at all times  Boards should – set basic goals for the firm’s risk appetite and strategy, – review and affirm management’s articulation of risk appetite, and – ensure that risks are comprehensively considered and managed  CROs should (and should be empowered to): – assess and control the firm-wide risk level – provide an integrated view of the overall risks the firm faces, and – ascertain that the firm’s risk level is consistent with its risk appetite  Supervisors have a role in assessing and challenging Boards’ and Managements’ achievement of these goals, risk awareness and understanding, and conformance to (evolving) best practice 5
  • 7. Section 2 UBS Firm-wide Risk Appetite Framework
  • 8. Earnings/Capital Waterfall Continuum – at Least in Principle Capital Criteria Earnings Criteria Solvency Regulatory Constraints View Rating Change Positive Earnings, Payment of Dividends Risk Exposure: Mean Earnings Deviation from Mean Earnings at: Risk Probability 99.9+% 95% 0 Cushion Capacity / Earnings Capital Dividend Earnings Power/Capacity Event Earnings/Dividend Capital Depletion reduction 7
  • 9. Evolution of Risk Appetite & Experience during the Crisis Shift to ensuring going concern under stress Traditionally, focus on:  Solvency perspective – Consideration of Economic Capital and total (or Tier 1) capital  Dividend paying ability in most years, also in adverse economic situation Experience during the crisis:  Focus on going-concern capital metrics (e.g., Tier 1 ratio) – Loss-absorbing capital is what matters  Consider scenario-based stress metrics in addition to statistical metrics – Look beyond historical experience  Ensure stable funding sources and ample liquid assets 8
  • 10. Implications for Risk Appetite Embedding multiple complementary criteria  Need for complementary criteria (with different time horizons and confidence/severity levels), representing different points in the financial structure/stakeholder waterfall. E.g.: – Traditional EC view at a high (99.9+%) confidence level over 1 year and/or multiple years – Tier 1 ratio or similar view at a lower confidence level over ranges from 1 quarter to multiple years – Earnings view at a lower (one in 5-25 year) confidence level over 1 quarter to 1 year time horizon  Focus on high-quality equity capital (convergence to Basel III or similar view) Multiple severity levels, metrics, and risk horizons 9
  • 11. UBS Firm-wide Risk Appetite Pillars UBS Risk Appetite Framework Minimum Tier-1 Earnings Capital Solvency Earnings should Loss-absorbing Ensure sufficient cover the risk capital is sufficient total loss- of losses in to absorbing capital most years meet regulatory to sustain even an + requirements even extreme stress Avoid repeated if a severe loss event (large) quarterly event were to losses occur Stress Stress Stress Stress Stress Statistical Scenario Statistical Scenario Statistical 10
  • 12. Risk Appetite objectives: Risk Capacity vs Risk Exposure } Buffer Taking into account strategic considerations Earnings Credit Risk Market Risk Capital Risk Appetite Issuer Risk Investment Risk Regulatory requirements Funding Risk and constraints Country Risk Pension Risk Operational Risk Risk Capacity Risk Exposure maximum amount of risk a firm is the amount of risk, by whatever technically able to assume given its metric, actually being taken at a capital base, liquidity, borrowing point in time, or expected/forecast to 11 capacity, and regulatory constraints be taken
  • 13. Overview of Firm-wide Risk Appetite Framework The framework encompasses all material risk categories, and plays a key role in the decision- making processes in the Bank Firm-wide Risk Appetite Framework Risk Capacity Risk Exposure  Business Plans E@R / C@R Exposure Firm-wide (projected net Stress Measures earnings and capital) Statistical Stress Risk Categories Measures Measures less  Business Risk Operational Credit Country Investment Pension Risk Funding Risk Market Risk Issuer Risk LU Risk (volatility in Risk Risk Risk Risk earnings) Consequential Risks Position Risks Granular Limit Framework The firm-wide statistical and stress metrics are complemented with a granular limit framework with portfolio and position limits Of the various scenarios in the Firm-wide Stress framework, the most relevant / severe one is used as the ‘binding’ scenario in the Risk Appetite Framework 12
  • 14. Risk Exposure: Firm-wide measures UBS has two complementary approaches – one statistical and one stress based Statistical measure which allows the aggregation of firm-wide risks using Earnings-at-Risk / statistical techniques which can then be tied to probabilities / confidence Capital-at-Risk levels (E@R / C@R) A large number of potential outcomes and associated losses is simulated, rooted in historically observed market changes More intuitive stress measure which calculates the impact of a scenario on Firm-wide Scenario the firm-wide portfolio including the causality chain by which losses would Stress Test arise if the scenario were to unfold Scenarios enable incorporation of forward-looking views Under both firm-wide measurement approaches, we model the first order P&L and capital impacts as well as the consequential capital impacts of downgrades in the Firm's portfolio and resulting adjustments to RWA 13
  • 15. UBS Approach for Firm-wide Stress Testing Scenario-based stress tests Risk Factor P&L impacts Sensitivities Macro-economic and/or OCI impacts Aggregation scenario Revaluation RWA impacts methodologies Various global Quantitative and Credit Risk Quarterly time profile of downturn scenarios qualitative analysis of • P&L (losses, earnings) historical data about Market Risk • OCI impacts defaults, Issuer Risk • Risk Weighted Assets impairments, write- downs etc. Investment Risk and ultimately Tier 1 capital ratio Funding Risk Operational Risk Tier 1 Capital Ratio Pension Risk Critical threshold Country Risk Business Risk Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 14
  • 16. UBS Statistical Risk framework Comprehensive assessment of risks Position Risks Consequential Risks Business Risks   = Aggregate Statistical Risk Market Operational Business Exposure Issuer Funding Targeted stress Expecte Probability Credit Pension components d Earnings Country Capture special risks not modeled statistically 0 Investment Earnings Step One Step Two Step Three  = Copula Aggregation  Aggregate Group Risk Exposure derived from probability distribution of potential earnings shortfalls, supplemented by targeted stress components.  Diversification between risk types is included at each aggregation step 15
  • 17. Section 3 Basel 3: A Stricter Diet
  • 18. Too-Big-To-Fail Sylvan Wegmann 17
  • 19. Basel 3: Increased Minimum Capital Requirements Following Basel Committee … … and with “Swiss Finish” BIS Basel 3 Phase-in - Minimum capital requirement FINMA Basel 3 Phase-in - Minimum capital requirement Global Systemically important Banks (G-SIB) Systemically important Banks (maximum 6% progressive component) 20% 20% 18% 18% 16% 16% 6.00% 5.63% 14% 14% 5.12% 4.50% 12% 2.5% 12% 3.75% 3.00% 1.875% 3.00% 10% 10% 2.875% 1.25% 2.75% 2.0% 2.625% 0.625% 2.0% 2.25% 8% 2.0% 8% 2.0% 1.5% 1.50% 1.75% 1.5% 5.50% 2.5% 2.0% 4.88% 1.5% 1.00% 4.25% 3.5% 6% 3.63% 6% 1.5% 2.5% 2.88% 1.5% 1.875% 2.75% 1.25% 1.5% 0.625% 2.50% 4% 1.0% 4% 2% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5% 2% 4.00% 4.50% 4.50% 4.50% 4.50% 4.50% 3.5% 3.50% 0% 0% 2013 2014 2015 2016 2017 2018 Basel 3- Full 2013 2014 2015 2016 2017 2018 Basel 3- Full G-SIB additional capital (max) Tier-2 Capital Additional Tier-1 Capital Progressive component (CoCos 5% trigger) Capital Buffer - CoCos 7% Trigger (max) Capital Conservation Buffer (CET1) Minimum CET1 Capital Buffer - CET1 (min) Minimum CET1 Excludes Countercyclical Capital Buffer (max 2.5%) 18
  • 20. Basel 3: Lower Eligible Capital + higher RWA AV Corr +1.4% CVA +9.3% RWA vs +7.6% Eligible Capital deductions -16.4% RWA -5.0% DTA + 18.4% -3.6% Inv. in Fin Institutions -2.0% Items > 15% CET1 Other -5.8% Source: EBA Basel III monitoring exercise, deductions average of Group 1 banks, Sept 2012 19
  • 21. In addition to impact of Basel 2.5 Stress VaR, IRC, CRM, and modified securitisation treatment increase UBS market risk RWA by 400% Source: UBS 3Q12 Report 20
  • 22. Basel 3: UBS RWA Targets Source: UBS 3Q12 Results Presentation 21
  • 23. Basel 3: New items on the menu Liquidity Coverage Leverage Ratio Ratio Net Stable Funding Ratio 22
  • 24. Basel 3: UBS Balance Sheet Development Influences Leverage Ratio capital requirement Target reduction of Assets excl PRVs to 600bn in 2015 Source: UBS 4Q11 & 3Q12 Results Presentation 23
  • 25. Section 4 Risk Appetite under Basel 3
  • 26. Basel 3 is estimated to lead to increased product costs Source: “Basel III and European banking: Its impact, how banks might respond, and the challenges of 25 implementation”. McKinsey & Company, Working Papers on Risk 26, November 2010.
  • 27. Basel 3: Capital Market Businesses are most affected Structured credit, rates, and equity most affected; FX and cash equities least Mitigating actions:  Portfolio optimization  Model refinements + data quality improvements  Conserving capital, liquidity and funding  Operational enhancements Source: “Day of reckoning? New regulation and its impact on capital-markets businesses”, McKinsey & Company, Working Papers on Risk 29, October 2011. 26
  • 28. Basel 3: Considerations for Earnings Objectives Focus on profitability of Core Businesses  Original objective (2003) was to ensure minimum dividend payment – Even in adverse situation, with high probability  Since the 2007-2008 financial crisis – Profits have been used to increase tangible equity instead of paying dividends – Risk taking has reduced substantially – Inventory of legacy exposures have been wound down – Market circumstances have been challenging  Focus on profitability instead of paying dividends – For Core Businesses - Legacy exposures supported by capital – Differentiated tolerance for losses in different businesses New balance to be found between risk and return 27
  • 29. Basel 3: Choices for Capital Objectives Sufficient capital to ensure going-concern after severe stress  Consider Basel 3 CET1 phase-in or fully-applied? – Regulatory capital based on phase-in – Analyst focus often already on fully-applied  What minimum CET1 ratio to choose under stress for Tier-1 Capital objectives? – Impairment of capital buffer requires plan to replenish the buffer – Impairment of capital buffer can lead to restrictions on shareholder distributions and discretionary pay – up to imposing measures to increase capital and/or reduce RWA – Latest point at which FINMA interferes is 8.75% CET1 ratio – 50% impairment of capital buffer – Well before triggering high-trigger (7%) CoCos  Maintain Solvency objective – Loss-absorbing capital as Risk Capacity  Alignment with Recovery and Resolution plans 28
  • 30. Potential Extensions of Risk Appetite objectives  Leverage ratio objective – Satisfying minimum leverage ratio also after a stress event? – FINMA leverage ratio denominator calculation (“assets”) to be finalized – Minimum leverage ratio requirement to be reviewed  Establish connection with liquidity framework – Minimum liquidity and funding requirements after a stress event – UBS satisfies existing interpretation of LCR and NSFR  Separate (but aligned) objectives for major legal entities  Cascade Risk Appetite objectives to Business Divisions – Continue to do so through limit framework – In addition, consideration of business-specific objectives Balance between comprehensiveness, simplicity & transparency 29