Topic: Simplifying the enterprise risk data aggregation challenge – Applying the replicating portfolio techniques to facilitate enterprise risk modeling

 Speaker: Michael Zerbs, Executive Vice President, Scotiabank

CCFA has successfully held another lunch-and-learn event on Friday, March 6th 2014. We were honored to have Michael Zerbs, an executive vice president of Scotiabank who is responsible for the development and execution of strategic technology plans to support the key functions and business lines at the enterprise level. Michael introduced the replicating portfolio techniques for facilitating enterprise risk modeling. More than 70 professionals from the financial industry participated in this event. The talk was well received and ended with an animated Q&A session showing very good feedback from the audience.

Since the Lehman collapse in 2007, people started realizing that the lack of data aggregation governance, architecture and processes can brought enormous damage to the financial institutions. Financial institutions tried to tackle the risk data aggregation issue through a lineage data flow lifecycle. However, since the lack of risk awareness at the senior level, most of the financial institutions wasn’t able to timely and adequately aggregate the risk data. Hence, the long-term risk aggregation could raise more uncertainty from the process. As we don’t want to fight a complex problem with a complex solution, Michael introduced a different approach – replicating portfolio.

Replicating portfolio technique is to use a portfolio with the same risk characteristics to replicate the target portfolio, and perform optimization techniques to implement large scale risk simulations on the replicating portfolio. Michael briefly introduced the replicating portfolio process in insurance industry and how can replicating portfolio optimize asset selection strategically against liability risk profile and address on industry challenges such as the complexity of large insurer profiles and different legacy systems. In more specific, Michael used annual variable annuity cash flow portfolio in insurance as an example, to illustrate replicating portfolio technique’s performance in both in-sample and out-of-sample scenarios, as well as its trading budget efficiency. Michael emphasized that applying replicating portfolio to risk management is as much art as science by its unique characteristics. Michael also introduced a few other use cases of replicating portfolio such as strategic portfolio hedges and black swan hedges. At the end, Michael highlighted that developing awareness for the many judgment calls and modeling decisions would also be essential for enterprise risk management.