Annual report 2010 - Dexia.com

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Risk managementManagement reportConsolidatedfinancial statementsAdditional information Annual financial statementsMarket riskDexia policyIn order to have an integrated and sound market riskmanagement, Dexia developed a framework based on thefollowing components:• a comprehensive risk measurement approach, whichconstitutes an important part of the process of monitoringand controlling the Group’s risk profile;• a sound structure of limits and procedures that governrisk taking. The limit system must be consistent with theeffectiveness of the organisation’s overall risk measurementand management process and with the adequacy of thecapital position. These limits are integrated to the fullestextent possible;• a strong risk management organisation responsible foridentifying, measuring, monitoring, controlling and reportingrisk. The development of an enterprise-wide risk managementframework must be responsive to the nature of the challengesthe bank has to face. This approach provides the managementwith the assurance that risks are being managed in accordancewith Dexia’s strategy and objectives and with the overall riskappetite framework.Risk measuresThe Dexia Group adopted the VaR (Value at Risk) measurementmethodology as one of the leading risk indicators. The VaR isa measure of the potential loss that can be experienced witha 99% confidence level and for a holding period of 10 days.Dexia applies multiple VaR approaches based on their abilityto measure market risk accurately in different market activitiesand portfolios.• General interest-rate and forex risks are measured througha parametric VaR approach.• Specific interest-rate risk, equity risk and other risks intrading books are moreover measured by means of a historicalVaR approach.• Non-linear and particular risks are measured throughspecific and historical VaR methodologies with a view to amore appropriate measurement of the sensitivity to marketvolatilities.Dexia exposure to market risk as measured in Value at Risk(VaR) terms stems mainly from general interest-rate risk andspecific interest-rate (spread) risk reflecting today’s volatility incredit markets, while its market exposure arising from tradingpositions in equity, exchange and other risk factors remainsmuch lower.Dexia applies the internal VaR model for the regulatory capitalrequirement calculus on foreign exchange risk and generalinterest-rate risk within the trading scope.The VaR methodologies are improved on an on-going basis.The “Market Risk Engine” project was launched in 2010.It aims for an historical VaR over all risk factors (with acomplete revaluation on non-linear risk factors); a completehistorical VaR which is confirmed as the standard in manybanks will provide a consistent and more precise measure.In addition to VaR, the new tool will facilitate stress testing,the analysis of extreme values and so on. The first phase ofthe project has already been successfully implemented andenabled existing historical VaR to be consolidated, historicalVaR to be added on the basis of sensitivities and progress tobe made on implementing the Stressed VaR as requested bythe regulator.In 2010 back-testing generated three exceptions for interestraterisk and foreign-exchange risk (internal model), threewithin the equity risk scope and none on spread scope, whichproves the quality of the tools used.As a complement to VaR measures and statement of incometriggers, Dexia applies a wide range of other risk measures inorder to assess risks related to the different business lines andportfolios (nominal limits, maturity limits, market limits andlimits on authorised products, sensitivity limits and Greeksand scenario analysis).Stress-testing is becoming increasingly important for soundrisk management as it explores a range of low-probabilityevents outside the predictive capacity of VaR measurementtechniques. As such, VaR measures assess market risk in adaily market environment, whereas stress-testing measuresmarket risk in an abnormal market environment. In thiscontext, the range of scenario assumptions was regularlyrevised and updated. The results of consolidated stress testsand the corresponding analyses are presented quarterly to theMRGC and the DMRC.The bond portfolio on the banking books is not subject toVaR limits, given its different investment horizon. Followingthe Dexia transformation plan, this portfolio is largely inrun-off.Exposure to market risk (1)Value at RiskThe detailed VaR use of market activities (bond portfolio inbanking book not included) is disclosed in the table below.Average global Value at Risk amounted to EUR 44.6 million in2010 (as compared to EUR 78.4 million in 2009).Substantial limit reductions have been implemented, in linewith the risk appetite reduction as included in the overallDexia transformation plan. The global limit has been reducedfrom EUR 178 million in the third quarter of 2008 to EUR 130million at the end of 2008 and to EUR 100 million since thebeginning of 2009.Bond portfolioDexia (excluded BSM portfolio and Financial Products, seebelow) manages bond portfolios, largely in run-off, amountingto EUR 138.5 billion as at 31 December 2010 (againstEUR 165.5 billion as at 31 December 2009). The sensitivityin economic value of these bonds portfolios is very limited, asinterest-rate risk is hedged.An important part of the bond portfolios is classified inLoans & Receivables. The AFS reserve of these securities isinsensitive to the market spread evolutions. Regarding theother bonds portfolios classified in AFS, the sensitivity in fair(1) More information is given in the note 12.5. “Market risk & BSM” to theconsolidated financial statements (page 225).84 Dexia Annual report 2010
Risk managementVALUE AT RISK OF MARKET ACTIVITIES(in millions of EUR) 2009 2010IR (1) & FX (2)(4)EQT Spread OtherEQT Spread OtherVaR(Trading et Trading Trading risks (5) (Trading et Trading (4) Trading risks (5)(10 days, 99%)Banking) (3)Banking) (3)By activity Average 30.1 4.6 39.3 4.6 16.6 2.1 22.4 3.5Maximum 86.5 9.7 59.2 7.8 28 4.7 30 5.8Global Core (6) Legacy (6) Core (6) Legacy (6)Average 45.7 41.9 30.4 23.5Maximum 103.6 58.5 44.1 32.7End period 37 29.4 27.8 15Total 2009 Total 2010Average 78.4 44.6Maximum 137.8 55.5End period 45.7 39.1Limit 100.0 100.0(1) IR: interest rate.(2) FX: forex.(3) IR & Forex: without BSM.(4) EQT: equities.(5) Other risks: inflation, commodities, CO 2.(6) “Core” refers to assets considered by Dexia as being part of its core businesses while the Legacy portfolio contains the run-off assets, in line with theAgreement with the European Commission. More detailed information on the Legacy Divsion is provided in the chapter “Update on the transformation plan”of this annual report (page 13).value after a basis point credit-spread increase amounted toEUR -35.46 million (against EUR -36.18 million/basis point as at31 December 2009).Given the illiquidity of markets and the reduced possibility ofhaving “observable” prices/spreads in the valuation process,a mark-to-model valuation development was performedon the illiquid part of the available-for-sale bond perimeter(AFS).The valuation principles used by Dexia for its financialinstruments are detailed in the section Fair value of financialinstruments in the Accounting principles and rules ofconsolidated financial statements (page 133) in this annualreport.Balance Sheet ManagementDexia policyDexia is conservative in term of Asset and LiabilityManagement. The main objective is to minimize P&L volatilityand to preserve value. There is no objective of creatingadditional revenue through voluntary interest-rate risk taking– focus is on stabilising global bank earnings.Interest-rate sensitivity measure is considered as the main riskmeasurement tool (full revaluation expressed in sensitivityterms). Although a parametric VaR (indicative) is calculatedat Group level based on interest-rate sensitivities, global andpartial risk sensitivity per time bucket remain the principalrisk indicators based on which the ALCOs manage their riskexposures.Risk measuresInterest rateThe role of BSM in the management of interest-rate riskconsists on the one hand of reducing the volatility of theP&L, thus immunising the commercial margin generated bythe business lines, and on the other hand of preserving theoverall value creation of the Group.Measurement of balance-sheet risks is harmonised among theGroup’s various entities. Sensitivity of the net present value ofBSM positions to an interest-rate trend is currently the mainindicator for fixing limits and monitoring risks.The structural rate risk of the Dexia Group is concentratedprincipally on European long-term interest rates and resultsfrom the structural imbalance between Dexia’s assets andliabilities.Risk sensitivity measures reflect the balance-sheet exposure tofirst and second order sensitivity and to behavioural risk. VaRcalculations are additional indicative measures.Credit spreadThe credit spread is defined as being the specific interest-raterisk capturing individual issuer-related causes. This is due tovariations in the spread of one specific signature within arating class and is measured with sensibility measures (/basispoint).Management reportConsolidatedfinancial statementsAdditional information Annual financial statementsAnnual report 2010 Dexia85
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