Risk reports should enhance risk communication across different levels of the firm, from the trading desk to the CEO. In this chapter, we focus on daily management VaR reporting. Public risk disclosures are discussed in Chapter 6, risk performance and capital reporting in Chapter 7, and credit exposure reporting in Appendix B.
In order of importance, senior management reports should • be timely,
• be reasonably accurate,
• highlight portfolio risk concentrations, • include a written commentary, and • be concise.
(a) Risk reports must be timely
Risk management is a proactive discipline, and the time decay in the value of daily risk reports is high. Risk reports must therefore be timely and reflect current risk positions. For example, traders may look at instantaneous risk calculations, while senior trading desk managers may review risk snapshots throughout the day. At J.P. Morgan, senior managers review the daily cross-firm risk report before close of business; it gives a rough snapshot of market risks toward the end of the trading day, when guidance can be provided to managers in the next time zone on risk appetite, position unwinding, or macro hedges.
(b) Risk reports should be reasonably accurate
Risk management is not a precise science. The accurate prediction of risk is complicated by theoretical and practical constraints (e.g., unexpected events occur, certain risk factors may not be quantified due to expense or lack of data, market and position data may be delayed or incomplete, and risk methodologies are still evolving). Nonetheless, risk man- agers should strive to be as accurate as possible, given these constraints. The credibility of the risk management effort suffers if reports are considered inaccurate or unrealistic.
Timeliness vs. accuracy
Risk managers may need to sacrifice some accuracy for timeliness. For example, many financial institutions use a same- day report for management purposes, even though they cannot reflect 100% of their positions. A financial control group generally processes a more complete next-day report to verify the accuracy of the previous same-day report. Red flags come up only if there are glaring differences between reports.
The chairperson of one global bank’s daily market risk meeting puts it succinctly: “Having mostly accurate information and people in the meeting who know what’s missing is better than a fully accurate report one day too late.” Or, as J.P. Morgan’s former CEO Dennis Weatherstone famously said: “I’d rather be approximately right than precisely wrong.” This practical focus illustrates an important difference between accounting and risk measurement: whereas accounting seeks to represent the past as accurately as possible, risk measurement seeks to capture conditions on the fly.
(c) Risk reports should highlight risk concentrations
Risk reports should show risk concentrations by risk taking unit, asset class, and country. For fixed income, it may be useful to look at risk by maturity bands to quantify yield curve risk. Risk can be viewed down to the instrument level and trader. Total portfolio VaR should be prominently displayed, and graphs of the entire distribution of potential returns should be available. VaR vs. limits is also useful to include for management control. The specific information in each internal management report varies by level of organiza- tion, from macro risk summaries at the corporate level, to detailed risk reports by specific instrument at the desk level, as shown in the following table.
Specific risk reports are described in Section 5.2. Regulatory reporting and external VaR disclosures are discussed in the next chapter.
Reporttype Content
Corporate Level • Shows total firmwide risk and summary of risk concentration among differ- ent business units, asset classes, and countries.
• Breaks down VaR vs. limits by business unit, asset class, and country. • May include commentary on size of market risk, significant risk concentra-
tions, and interesting market developments. • May include legal entity and regional reports. Business Unit
Level
• Summarizes risk by trading desks, country, maturity band, and instrument type.
• Reports VaR vs. limits by total business and individual desks. • Optionally includes
- Marginal VaR* report by desks, country, maturity band, and instrument type.
- Cashflow Map† or Present Value Report† by currency.
Desk Level • Shows detailed risk summary by instrument, position, and maturity band. • Includes
- VaR vs. limits by desk and trader.
- Marginal VaR report by instrument or instrument type. - Instrument Summary† report.
- Cashflow Map by currency. * See page 58.
Sec. 5.1 What makes a good risk report 57
(d) Daily risk reports should include written commentary
Daily risk reports can be enhanced with a qualitative market risk commentary emphasizing notable market developments and risk positions. Often, risk monitors add the commentary after participating in a daily market risk discussion with risk takers and business managers. Commentaries should be brief and to the point (... and distribution of the reports should not be slowed while a risk manager struggles with writer’s block).
Written commentary is considered especially important for corporate managers, who may not be in touch with minute-by-minute developments on the trading floor. Written com- mentary adds color from the front lines, improves communication between the trading floor and the corporate office, and facilitates centralized risk management with decentral- ized position taking.
(e) Risk reports should be concise
Keep summary risk reports to one page containing only essential risk information. No one has the time to be overwhelmed by thick reports full of numbers.
A sample daily market risk commentary:
Market Risk Commentary, Wednesday, March 17, 1999
Global market volatility has continued to increase, with widening credit spreads and decreased liquidity for risky assets across Europe and the Americas. Trading volume across U.S. fixed income was unusually low, and corporate bond trad- ers note declining liquidity and increasing spreads due to a flight to quality. The firm’s large inventory of corporates could suffer from further widening of spreads. Brazilian markets continue to bleed, with uncertainty surrounding impending fiscal reforms. While mostly FX hedged, the Emerging Markets desk is close to its $2MM VaR limits and could suffer large bond losses if Brazil is forced to raise interest rates to stem capital flight. A Latin American liquidity crunch could put pressure on Emerging Asia again, where the firm has long positions in THB, MYR, and SGD government paper. The FX desk reported significant trading by macro hedge funds, mostly short interest in long dated JPY/USD forwards and options. U.S. equity markets continue to be volatile, with Internet stocks racing ahead. However the bank’s direct equity exposure is currently low due to short SPX futures positions in proprietary trading which offset some systemic risk in market making books.