avantage Presentation on FSA PS09/20 on Stress Testing and Scenario Analysis

Andrew Nord, Partner, avantage began proceedings by welcoming participants and introducing the topic observing that PS09/20 on stress testing and scenario analysis presents both implementation and preparation challenges. Whilst the provisions relating to stress testing have been in operation since 14 December 2009 many institutions face a particular challenge in preparing to implement the reverse stress testing provisions which are effective from 14th December 2010.

Trevor Wells, who leads the scenario analysis at UBS Investment Bank, spoke on issues relating to stress testing across all risk types. His presentation took into account changes made by UBS since their well publicised write-offs. Given that UBS made early efforts to address these shortfalls, the outcomes can be considered as good practice within the industry at this point in time. He gave a brief introduction to the role of stress testing before going on to explain the Liquidity Adjusted Stress measures used at UBS. He explained how credit and market risk were bought together in a consistent framework at a Group level leading to an increased transparency and the reduction of the administrative burden of running separate scenarios. Key success factors to appropriate stress testing and scenario analysis were held to include: an integrated IT platform; scenario consistency; Stakeholder buy-in and alignment; and ensuring that the scenarios remain relevant in changing times.

Trevor's concluding remarks were reserved for the topic of reverse stress testing - citing the challenge of developing scenarios that are sufficiently extreme to "break the bank" but that also remain plausible when discussing them with senior management - so as not to undo the gains made through building credibility from positioning stress testing as more than just a theoretical exercise and as one tool that can provide management with information with which to make better risk adjusted decisions.

Colin Burke, Head of Technical Model Oversight at Lloyds Banking Group, spoke on the topic of stress testing challenges for counterparty risk. He began by providing an overview of the new "Basel 3" proposed rules for counterparty risk, including the challenge of measuring wrong way risk via stress testing. He explained the various modelling approaches to counterparty credit risk and the use of model outputs. He used the example of Morgan Stanley and 3M Libor to emphasise that whilst it is theoretically possible to introduce new approaches to measuring some risks, applying such techniques to draw conclusive insights is in reality difficult to achieve. His view is that increased sophistication in modelling should be used in conjunction with expert opinion to inform business decisions.

Andrew Shiels, Head of the avantage Edinburgh office, shared insights from working on a stress testing assignment. He explained the approach to delivering a robust and repeatable stress testing that moves from being a one of exercise to being embedded as business as usual. He then spoke in more detail on the case study, drawing attention to the key opportunities and benefits, including that the most anticipated or valuable business outcome is the use of the output from the scenario planning and stress testing in influencing the strategic decision making process at Executive level.

Dean Mitchell, Managing Consultant for avantage in Edinburgh, provided summary and concluding remarks, and advised that avantage would be issuing a Practice Note on the subject of stress testing and scenario analysis.

Download a copy of the speaker presentations here.

Download a copy of our our Practice Note ‘FSA Policy statement (PS) 09/20: Stress and Scenario Testing’ here.