Reviewing governance expectation and variations in views across the industry

Reviewing governance expectation and variations in views across the industry

  1. Nadir, thank you for your participation at the Center for Financial Professionals’ Liquidity Risk Management Forum 2017. Can you please tell our readers a little about your professionals background, and how you came to becoming a liquidity risk manager?

I have been in the financial services industry for over 10 years and have worked across all the three lines of defence when it comes to liquidity; from being an Internal Auditor in charge of Finance and Treasury to managing the funding and liquidity profile in Treasury; I am currently working in the Group Risk function overseeing Treasury’s liquidity risk management activities. My expertise ranges from defining and implementing the governance framework for liquidity risk management to the in-depth modelling of liquidity risks inherent in secured financing transactions across various platforms, derivatives and currency exposures. This skill-set is well complemented with my knowledge and experience of the Funds Transfer Pricing processes not only relating to the charging of the businesses’ balance sheet usage but also the charging of costs of liquidity reserves maintained to mitigate liquidity risks generated by businesses.

  1. Without revealing too much, how do the definitions of Governance vary across organisations and departments and what impact does this have?

Governance around liquidity risk has evolved over the years. Given the increasing focus from the regulators post the financial crisis, the industry has moved on. Governance is now seen as a broad suite of activities that involve, not only liquidity risk modelling based on stress tests (idiosyncratic/market as well as ad-hoc scenarios) but also complementary measures, including but not limited to:

  1. establishing liquidity limits framework over business activities/transactions generating liquidity risk that have not been modelled in the stress test,
  2. horizon scanning via the use of EWIs to indicate imminent idiosyncratic/market stress,
  3. transaction governance framework for new products and modified/non-standard transactions,
  4. overseeing forecasting and planning activities (i.e. funding plan) to ensure that internal/regulatory liquidity metrics are catered for in the forecasting process,
  5. participation in group/regional/business committees not only in a BAU environment but also amidst crisis e.g. committees that oversee the implementation of CFPs and/or RRP in a stressed environment, and
  6. Liquidity impact assessment of upcoming regulations affecting businesses and its implementation.

Compared to other well-established risk types (i.e. Credit and Market risk) where activities around model development, risk management and independent model validation are segregated and performed by in Group Risk, similar activities for liquidity risks are not well-defined and segregated. Historically, models quantifying liquidity risk based on stress test were developed by Treasury who would also evaluate and oversee the results of these models, thereby managing liquidity risks measured by such models. The models were sparingly used to manage the day-to-day business activities. At the same time, Group Risk may exercise limited oversight over these models most of which were not subject to independent model validation due to their non-quantitative nature.

Most of the banks have now aligned or are in the process of aligning liquidity risk management activities to mirror the risk management model similar to Credit and Market risk, i.e. liquidity stress test modelling and associated activities being performed by Group Risk and validation of liquidity risk models by an independent Risk function. This leaves Treasury to focus on BAU liquidity management activities, drive businesses’ behaviour and the forecasting/planning of funding/liquidity sources and needs.

  1. Why is it essential for institutions to explore the landscape of governance across institutions?

Given the ever-changing regulatory landscape affecting institutions’ assessment, measurement and management of liquidity risks, globally and regionally, it is important for institutions to explore the landscape of governance across institutions. This would enable institutions to appreciate the best practices in liquidity risk measurement (modelling of stress tests) employed throughout the industry and standardize the interpretation/application of liquidity regulations as well as serve as a lobbying platform when it comes to consultations on prospective regulations.

  1. How do you see the industry evolving over the next 6-12 months?

Management of liquidity risk continues to be a priority not only for treasury and Risk departments in institutions but also regulators. Given the focus on short-term metrics like LCR together with the need to have stable long-term funding sources under NSFR (not yet legislated), this will require a balancing act by institutions who would also have to accommodate upcoming MREL and TLAC requirements in an environment where leveraged balance sheet is constrained. This is further complicated by changes in business/operational environment (e.g. margining of uncleared derivatives, etc.) that require (or generate) liquidity and need to be accounted for in BAU environment as well as in stressed conditions. This further emphasises the need for best practices when it comes to the management of liquidity risk.