Tailored Economic Scenario Generators (“ESG”) solutions ...€¦ · • An Economic Scenario Generator (ESG) is a model used to projects the value of economic parameters (e.g.,

Reacfin Online ESG solution and user guide © Reacfin, Place de l’Université 25, 1348 Louvain-La-Neuve, Belgium - M: [email protected] – T: +32 (0)10 84 07 50

© Reacfin (2016)

Place de l’Université 25, 1348 Louvain-La-Neuve, Belgium

M: [email protected] – T: +32 (0)10 84 07 50

Tailored Economic Scenario Generators (“ESG”) solutions Presentation

Please read the important disclaimer at the end of this presentation

mailto:[email protected]



2

This page is left blank intentionally



3

Table of content

SECTIONS

CONTENT

What is an ESG

Reacfin’s tailored solutions

High-level model architecture

Integration in full balance-sheet projection frameworks

Model granularity

• Reacfin’s ESG solutions

• On-line demo

• About Reacfin



What is an ESG ?

• An Economic Scenario Generator (“ESG”) is a model used to projects the value of economic parameters (e.g., stock returns, interest rates, corporate bond spreads, property values) into the future through Monte-Carlo simulation techniques

• It creates numerous possible scenarios for the evolution of such macro economic and market variables. The output of an ESG are thus time-series of variables for different possible evolutions of world (“scenario’s”)

4

• Risk Drivers are the fundamental parameters (the building blocks) which determine the risk & performance profile of a specific asset or liability

• E.g. in the market risk model a mapping is needed to picture the evolution of the asset prices through the evolution of a limited number of risk drivers.

ESG’s simulate risk drivers, not prices, values or balance-sheets items

Equity Price Indices

Credit Spreads

Yield Curve

Inflation

Corporate Bonds

Shares

Inflation Linked Bond

Market Instruments Risk drivers

Illustration



• The solutions proposed by Reacfin consists in both Real-World and Risk Neutral ESG solution available on- &

off-line that are tailored to the specific requirements of our clients. We further offer our clients full access to our

ESG Code.

• The solution proposed by Reacfin is not a software but rather a methodology supported by a set of tools

(preprogrammed elements in R, Matlab or VBA and including some embedded sub-routines in C++ to ensure

adequate calculation speed) . These are then assembled & tailored along the specific requirements of client to

ensure the delivered results exactly fit our client purpose.

• Through a very user-friendly graphical interface (e.g. browser-based*), our ESG solutions can be operated and

calibrated by users having no particular programming skills nor advanced knowledge in stochastic finance or

calibration of financial ESG’s

• Finally, at the single click of a button, all results can be obtained in various format (e.g. as CSV files) allowing

further use in most other systems (e.g. Excel, R, Matlab, SAS, etc.)

5

Reacfin’s tailored open-source ESG solutions

We propose tailored ESG

solutions thoroughly owned

by our client’s staff, which

can periodically be remotely

calibrated by our personal

and further easily operated &

interpreted by a large range

of our client’s staff.

(*) Compatible with most standard internet browsers incl. MS-Internet Explorer, Apple’s Safari, Google Chrome, Firefox, MS-Edge, Opera, Wyzo, etc.



6

Typical high-level Model Architecture

Input assessment Configuration Files

Calibration parameters

Inputs Downloadable Output

CSV file

CSV files containing: • Historical time series • Modeling assumptions • A –priori calibration

assumptions

ESG Calibration Tool

ESG Scenarios CSV file

Graphical interface to check sanity of inputs & selection models assumptions

Automated calibration engine allowing also manual expert judgement corrections

Single processes parameters Expert corrections Correlations

ESG Simulation Tool

Projects Risk Drivers over user-defined time horizons and frequencies

Results assessment & Testing tools

Visualizing simulation results and performing adequacy tests

ESG Tool



7

Designed to be integrated in full balance-sheet projection frameworks

ESG Tool

ESG Scenarios

Instrument Tool

Instrument Scenarios

Balance Sheet Tool

Balance Sheet Scenarios

Calibration and simulation of risk drivers (e.g. interest rates, credit spreads)

Projection of individual instruments (e.g. FV, duration, SCR consumptions, RWA, IFRS impairments, defaults & recovery values…) based on ESG Scenarios & assets characteristics

Projection of balance sheet (FV, Incomes, duration, Available & Required Capital, …) considering reinvestment rules, business plan and allocations to the individual instrument scenarios. Limits set on Solvency Ratios, Liquidity requirements, P&L volatility, Leverage Ratio , etc.

Results Analysis Tool Production of comprehensive analysis reports & dashboards, optimization tools for SAA pruposes, etc.

Our ESG

solution is

further

designed to

integrate into

Reacfin’s set

of tools for

portfolio- and

balance-sheet

projections.



8

Key dimensions of risk drivers modeling granularity

Fixed incomes

Split per type of assets or liabilities*

Split per geographies

Split per maturity bucket

Split per rating

Other

Split per type (e.g. RE, Equities, HF, etc.)

Split per

geographies

Possible level of granularity currently foreseen

Split per Sectors

Granularity may further be increased considering bespoke developments

(*) e.g. Sovereign bonds, Quasi-sovereigns, Covered Bonds, Corporate Bonds (possibly slit per sectors), Structured credit instruments, Inflation linked instruments, etc.



9

Intergation in Reacfin’s SAA suite of tools

Overall architecture

ESG & Total Return

Optimization

Instrument tool

Balance-Sheet tool

Portfolio selection tool

What it does • Generates scenario’s for Risk drivers (Rates, Spreads, Eq. & RE returns, etc.)

• Performs initial total return optimization (to assess calibration & identify some relevant portfolio’s)

• Under each scenario’s generates at all time all possible single instruments (for fair value, Cash-flows, durations, ratings, etc.)

• Projects balance sheet and calculates relevant indicators (incl. FV, Incomes, Duration, Solv. Ratio’s, limits breach, Liquidity requirements, etc.)

Projection tools Optimization tools

• SAA optimization given wide sets of optimization criteria’s and constraints



10

Table of content

SECTIONS

CONTENT

Where to find Reacfin’s on-line ESG – Demo

Defining the types of simulations

Visualizing the results


• On-line demo

• About Reacfin



Where to find Reacfin’s on-line ESG - Demo

Simplified version available for demo purposes on http://apps.reacfin.com/ESG/


http://apps.reacfin.com/ESG/




12

Defining types of simulations

ESG modeling principles

• Interest rates o Mean reverting stochastic processes o Stochastic models per maturities allowing negative rates (through displacement factors) o To be calibrated: Initial investable rate levels, LT mean reversion levels, mean reversion speed, volatilities,

displacement factors*

• Credit Spreads (for different asset classes**) o Mean reverting stochastic processes with transition probabilities o Stochastic models per ‘full letter’ rating (for bonds***) allowing negative spreads (through displacement factors) o Deterministic term structure which can be made specific for each asset class o To be calibrated: Initial investable spreads levels, LT mean reversion levels, mean reversion speed, volatilities,

probabilities of rating transitions (transition matrices) , displacement factors*

(*) Calibrated as twice worst historical observed (**) See slides dedicated to ESG granularity (***) For loans: performing or defaulted

• Non-Fixed Incomes o Equities, Real Estate & Alternative Investments o Non-reverting processes with constant incomes yields (e.g. dividend yields or rental incomes) o To be calibrated: Long term average total return, volatility, incomes yield

• Dependencies structure o Constant Correlation matrices o Possibility to foresee dimension reduction using PCA approach




Selecting stochastic models

Select the first tab ‘Input”

Our on-line demo version is limited to 5 main asset classes and each of them may be modelled either using 3 types of processes: • Geometric Brownian Motions (GBM) • Displaced Black-Karasinski (BKD) • Displaced Cox-Ingersoll-Ross (DCIR)

Our professional tailored versions will allow you to model a large number of

additional risk drivers using wide range of stochastic models

In first tab “Input”



14

Illustrative example: Dispersion of the projections for 3 Months € interest rates Calibration period: from 2000-01-01 to 2014-11-05

Black-Karasinski Cox-Ingersoll-Ross

Log-Normal distribution for the changes in rates (proportional to the IR level)

Chi-Squared distribution for the changes in rates (proportional to the square root of the IR level)

Percentiles:

• Geometric Brownian Motions (GBM): Constant trend and normally distributed random increments • Displaced Black-Karasinski (BKD): Mean revering processes with log-normal distribution of random increments • Displaced Cox-Ingersoll-Ross (DCIR): Mean revering processes with random increments having a Chi-square distribution

Selecting stochastic models

Defining types of simulations In first tab “Input”



15

• Our online demo-model generates correlated risk drives for: o Different maturities of interest rates o Different rating buckets (Investment Grade only) of 5 years credit spreads

• Given the large number of risk drivers simulated, some unwanted behaviors (e.g. too frequent interest rates curve inversions or a-typical inversions for spreads along ratings) can happen.

• To limit such issues, users may thus chose to reduce the number of random variables (factors) used for each risk drivers (using principal components analysis techniques).

Selecting the number of stochastic factors


In first tab “Input” Under the « Select Models » menu




16

• Per default all processes are calibrated historically (based on monthly data only for the online demo*)

• The longest possible data series ranges from Jan-2000 to October 2014**

• Users may select to calibrate their models on part of these data only by modifying the “Date Range” as illustrated below.

Selecting the calibration period


(*) Calibration on daily (and in some cases even intra-day) data possible in the professional tailored versions

(**) Unlike our professional tailored versions, in the on-line demo user cannot modify the historical data series used for calibration

In first tab “Input” Under the « Select Factors » menu




17

• At the bottom of the first tab ”Input”, users may then define:

o the start date of their stochastic simulation

o The number of simulations to be performed

o The number of years over which simulations have to be performed (the “Projection Horizon”)

o The frequency of simulated points of this projection horizon (in the demo version*: annual or monthly)

• For instance, in the example illustrated on the right, the model will thus project 1000 scenarios each starting on April 14th 2016. Since we chose to project annually over a 10y horizon we will thus get 1000 simulations for each of the following dates: 14-Apr.-2017, 14-Apr.-2018, … ,until 14-Apr.-2016

• To launch the calculations, click on the black button “Calculate”.

• Then switch to tab “Outputs” to see the results.

Simulation options


(*) Unlike our professional tailored versions which will also offer different frequencies of projections (e.g. quarterly, weekly, daily, tailored)


• Large numbers of simulations (especially on monthly step sizes) may induce long computation times.



18

Simulation options

Visualizing the results In second tab “Outputs”

Select the second tab ‘Outputs”

This grey tag indicates the program is computing and results are about to come

Select here the asset class you want to visualize

Select here the sub-asset class characteristics you want to visualize (e.g. maturity or rating)

Tick this bow if you want to visualize projection results together with the historical time series that where used for calibration



19

Simulation options


Select the second tab ‘Outputs”

This grey tag indicates the program is computing and results are about to come

Select here the asset class you want to visualize

Select here the sub-asset class characteristics you want to visualize (e.g. maturity or rating)

Tick this bow if you want to visualize projection results together with the historical time series that where used for calibration



20

Charts options


• All charts of our are produced using Ploty (https://plot.ly/feed/) and are thus interactive charts

• By passing your mouse over a chart, the following option icon menu will appear in the upper-right corner

Download chart as a png image

Save chart on Ploty server for editing

Zoom on selected part of the chart

Explore (“pan”) the chart when zoomed

Zoom in and zoom out at the center of the chart

Reset axis

Auto scale


https://plot.ly/feed/

https://plot.ly/feed/


21

Visualizing the results

Screenshots of the ESG

ESG set-up & definitions board Results assessment & calibration Scenario's & parameters exportation



22

Table of content

SECTIONS

CONTENT

Who we are

Our driving values

Reacfin’s management

Reacfin’s 4 core fields of expertise

What we deliver

Examples of recent assignments


• On-line demo User Guide

• About Reacfin



23

Who we are

Reacfin s.a. is a Belgian-based actuary, risk & portfolio management consulting firm.

We develop innovative solutions and robust tools for Risk and Portfolio management.

The company started its activities in 2004 as a spin-off of the University of Louvain, focused on actuarial consultancy to Belgian insurers, pension funds and mutual organizations. Rapidly, Reacfin expanded its business internationally and broadened its scope to various aspects of quantitative & qualitative risk management, financial modeling and strategic advice to financial institutions.

Spread over its 3 offices in Louvain-La-Neuve, Antwerp and Luxembourg, Reacfin employs about 30 consultants most of which hold PhD’s or highly specialized university degrees.

What we do

• Modeling

• Risk implementation advisory

• Validation & model reviews

• Specialized strategic risk consulting



24

Our driving values

Excellence: our outstanding feature

To deliver more than is expected from us, we attract the best people and develop their skills to the most cutting-hedging techniques supported by a robust and rigorous knowledge management framework.

Innovation: our founding ambition

Leveraging on our profound academic roots, we are dedicated on creating inventive solutions by combining our extensive professional experience with the latest scientific research.

Integrity: our commitment

We put work ethics, client's best interest and confidentiality as the foundation of our work. We are fully independent and dedicated at telling the truth.

Solution-driven: our focus

We produce for our clients tangible long-term sustainable value. We help our clients not only to reach the top, we help them reaching the stable top.

Reliability: our characteristic

We never compromise on the quality of our work, the respect of deadlines & budgets and our other commitments. We don’t produce reports, we deliver results!

We put great emphasis at strictly articulating our work around 5 fundamental driving values:



25

Reacfin’s management

Prof. Pierre Devolder (Chairman)

• Pr. Actuarial Science & Finance

• PhD in Sciences

• MSc. Actuarial Sciences

• MSc. Mathematics

• Non-Life Ex.Co. Member Axa Belgium

Xavier Maréchal

• MSc. Actuarial Sciences

• MSc. Civil Engineering

• MSc. Business Management

• Researcher in Actuarial Science and author of several refence books

Dr. Maciej Sterzynski

• PhD Economics

• MSc. Economics & Finance

• MSc. Law

• Specialist of qualitative Risk Management

• Co-Author of the CRD and Solvency II directive

Francois Ducuroir

• MSc. Appl. Mathematics

• Msc. Applied Economics

• Structured Solutions Benelux at Barclays Capital

• CPM & Capital solutions at BNP Paribas Fortis

• Prof. Banks & Fin. Instit Mgmt



Reacfin’s 4 core fields of expertise: Our centers of excellence

ALM, Portfolio Management & Quantitative Finance Implementation and calibration of stochastic models for

valuation, trading and risk Management purposes

Times series analysis & modelling

Pricing of financial instruments & development of ALM models

Design/review/implementation of systematic trading & hedging strategies

Business intelligence in ALM or Portfolio Management

Tools development (Valuation, Pricing, hedging, portfolio replication, etc.)

Design of Capital Management solutions

Insurance specialities

Life, Health and Pension

DFA* Models

Capital Requirement assessment

Business valuation support

Product development (pricing, profitability,..) & Reserving

Model validation

Non-Life

Reserving: triangle methods, individual claims modelling

Pricing: frequency and severity modelling, large claims analysis, credibility methods, commercial constraints

DFA models: cash-flows projection, calibration of models

Reinsurance: modelling covers, optimal reinsurance programs

Qualitative Risk Management, Restructuring & Operations

Organization & Governance

Businesses restructuring & change management

Implementation and industrialization of processes

Internal & regulatory reporting (KRI’s & KPI’s dashboards)

Model Review frameworks

Model Documentation

(*) DFA = Dynamic Financial Analysis

Risk & Portfolio Management

26



What we deliver

Balanced and pragmatic approach

No black box Solutions

Documentation, coaching &

training

Client-centric solutions focussed on deliverables Respecting the principle of proportionality Cost efficient within tight pre-agreed budgets

We deliver results, not reports! Open source solutions Close cooperation with our clients

Clear & comprehensive documentation compliant existing or upcoming regulation Adapted trainings at all levels of the organisation Coaching support for implementation and operationnalisation of processes

Clearly structured processes

Lean & efficient tailored project management Regular progress reviews Close cooperation with our clients

State of the art technical skills

Expertise in most advanced quantitative modelling & academic excellence of a spin-off All our consultants hold multiple masters or Phd. Best-in-class qualitative risk management leveraging on highly experienced senior consultants Hands-on implementation solutions, tested for real-world conditions

27



Strategic Asset Allocation for Bank & Insurance group

• Strong ‘natural’ unbalance between assets and liabilities durations

• Limited excess capital available

• Regulatory, accounting and Risk Management constraints

• Limited view on non-Govies asset classes & peers practices

• European Retail Bank with material insurance activities

• Aims at optimizing its asset allocation for both banking and insurance businesses

• Conservative risk profile materially constrained by board defined Risk Appetite

• Current allocation materially concentrates the portfolio in local Govies

Client Situation

• Robust target model portfolio’s for bank and insurance along 4 key dimensions (Asset types, Maturities, Ratings and Sectors)

• Proposal for rationale reinvestment rules depending on prevailing market conditions

• Introduction of new asset classes

• Improved NII, expected Total Return and Sharpe Ratio

• Asset allocation tool in R and in Excel

Results

Reacfin’s Contribution

Issues

• Exhaustive mapping and categorization of investable asset classes (using a benchmark based approach)

• Robust methodology for Risk, Returns & Correlations calibration

• Peers benchmarking through tailored surveys

• Modeling of portfolio dynamics under constraints of Capital consumption (both Basel II/III and Solvency II), Liquidity requirements, Accounting volatility, etc.

• Optimization both in Value & for NII for businesses independently and at bank-insurance group level

28

Example of previous assignment: All dummy numbers & graphs for illustrative

purposes only



Investment Portfolio Diagnostic

• Insurance Company operates under significant restrictions from regulator

• Portfolio inherited illiquid distressed positions.

• Liabilities expected to change significantly in the coming years due to change in corporate strategy.

• Large independent Insurance Company going through significant business model changes

• Portfolio Management, ALM and Risk departments in reorganization process

• Client asked Reacfin to review current portfolio for main drivers of risks & return, identify opportunities & threats and propose recommendations in term of investment strategy, processes and organisation.

Client Situation

• Benchmarking the portfolio for risk-return & dedicated visualization tools

• Estimating the benefit of diversification, its stability and its expected evolution.

• Recommendations for each asst classes

• Expected behavior of the portfolio under crisis situations.

• Process & organizational improvements

Results


Issues

• Modeling portfolio using over 50 different sub-asset classes both along market- & portfolio managers-based assumptions

• Modeling the « natural » evolution of the portfolio for short and mid term horizons taking into account insurances net in/outflows, expected maturities & coupons, defaults, growth, etc.

• Scenario & sensitivity analysis

• Interpretation of results and recommendations

29


purposes only



Strategic Asset Allocation Study for Pension Fund

Client Situation

Results


30

• Modeling of the asset classes using a rough aggregated asset but sufficiently in line with the risks and allowing for stochastic behavior

• Projections of liability cash flows and technical reserves

• Determination of decision criteria

• Client: Belgian Pension Fund

• Client asked Reacfin to analyze its strategic asset portfolio allocation and potentially suggest for modifications, improvement.

• Specificities as rebalancements constraints, reported loss, cash constraints

• Obvious and easy to understand decision criteria.

• Improved strategic assess allocation, (confirmed or adjusted) i.e. in line with risk tolerance of the management and expected return

• Better knowledge of the current and future potential risks depending on economy evolution

• Aggregation, modeling and calibration of assets.

• Generation of scenarios

• Projection of the different asset values along each scenario

• Thanks to a pension specialized partner, projections of the liabilities

• Definition of risk indicators taking into account asset and liabilities projections

• Computation of these risk indicators


purposes only

Issues



Pricing of a complex OTC derivatives

Client Situation

Results


31

• Understanding the complexity of the product and all the embedded options to identify the main underlying risk drivers

• Some underlying's of the derivative are themselves derivative products

• Several options to look at the product and to model it

• Client: tier-one European financial institution conglomerate having large OTC derivative positions on its balance sheet

• Client asked Reacfin to set up a stable process to quarterly fairly price this derivative depending on its main risk drivers.

• The Value at Risk of the price should also be assessed.

• Recurrent valuation of the product and its Value at Risk

• Better assessment of the valuation and the risk related to the product

• Balance sheet compliant valuation

• Implementation of a market consistent valuation of the product using a quantitative model including risk neutral economic scenarios generator (calibration and generation) of several market variables and a pricing tool.

• Documentation of the methodology

• Recurrent pricing reports (including Value-at-Risk)

• Sensitivity analysis


purposes only

Issues



Development of Heston model for Equity in a Risk Neutral framework

Client Situation

Results


32

• Reproduction of initial options market prices is inaccurate

• In classical GBM models, implied volatility is assumed constant, though it is not in practice

• Current calibration and simulation runtime is too long

• Client: International insurance company

• Client asked Reacfin to improve the risk neutral scenarios generated

• Reproduction of initial market prices is key in risk neutral framework


purposes only

Issues

• Determination of the model requirements.

• Calibration of the model on instruments market prices

• Implementation of martingale tests

• Integration in a whole economic scenario generators

• Introduction of dependence structure with the other risk factors

• Consequently improved reproduction of initial market price

• Generation of a stochastic volatility

• Consequent reduction of runtime



ALM Model development & implementation

Client Situation

Results & Benefits

Reacfin Contribution

Issues

33

• European insurance group

• Internal needs to produce appropriate risks and value metrics to support managerial decisions

• Internal requirements to manage the business in line with appropriate ALM indicators

• Pressure from regulators to improve risks and capital management

• Improved risks & business comprehension

• Assets and Capital managed with objective and exhaustive indicators

• Multiple uses for business management

• Fulfilled regulator(s) requirements with high appreciation level

• Optimal ratio "Complex tool/costs"

• Propose collaboration for model conception and metrics definition

• Definition of model scope, elements and customization level

• Model structuration and implementation

• Model testing, operationalization and documentation

• Operational implementation

• Continuation of developments with more accurate mechanisms & multiple add-ons


purposes only

• Create a multi-purpose tool satisfying the different stakeholders

• Insure exactitude for market consistency or/and regarding historic observations

• Tool should be auditable & operational

• Tool should be flexible and ready-to-be enhanced



Saving Accounts replicator portfolio

• Duration assumptions constraints imposed by local regulator

• Legacy model and related hedge

• Existing central software to be interfaced for FTP & NII calculation purposes

• Client: Belgian Bank-Insurance company

• Strong foothold in all 3 Benelux countries

• Recent development of retail business volumes

• Competitive pressure on deposit rates

• Pressure from local regulator to improve the modeling and hedging of non-maturing liabilities

Client Situation

• Improved NII margin through improved hedging strategy

• Automated tool enabling the simulation both ‘buy & hold’ investment strategies as well as constant duration rebalancing strategies

• Risk control & monitoring tools

Results


Issues

• Review & analysis of hedging techniques in place

• Split of overall saving account modeling within homogenous product categories for hedging purposes

• Development of a fully automated replicator model simulating ALM investment processes

• Selection of optimal hedging strategy per product categories & implementation of the propose solution

• Automated interface with the existing models

34


purposes only



Contact details

Place de l’Université, 25 B-1348 Louvain-la-Neuve

(Belgium) T +32 (0) 10 84 07 50

www.reacfin.com

35

François Ducuroir

Managing Partner

+32 472 72 32 05 [email protected]


http://www.reacfin.com/



Place de l’Université 25 B-1348 Louvain-la-Neuve

www.reacfin.com

Disclaimer:

The recipient of this document should treat all

information as strictly confidential and only in the

context stated below. Information may not be

disclosed to any third party without the prior join-

consent of Reacfin.

Estimates given in this presentation are based on our

current knowledge, they can be based upon our

previous experience within the Undertaking, as well as

taking into account similar projects in the same

context as the Undertaking, either locally, within

majority of the EU countries as well as overseas.

This presentation is only the supporting document of

a verbal presentation. Hence, it is not intended to be

exhaustive. Quoting or using this document on its own

might be misleading. As a result, these materials may

not be used by anybody except their authors nor

should they be relied upon in any way for any purpose

other than as contemplated by joint written

agreement with Reacfin.


Documents

Tailored Economic Scenario Generators (“ESG”) solutions ...€¦ · • An Economic Scenario Generator (ESG) is a model used to projects the value of economic parameters (e.g.,