毕博上海银行咨询Report to client (Final).doc

DRAFTASIAN DEVELOPMENT BANKOffice of the General AuditorFOR INTERNAL USE ONLY(Do Not Reproduce Return to OGA After Use)AUDIT REPORT ON FINANCIAL DERIVATIVESThis Copy: Draft Report No.419 May 1999REPORT ON AN AUDIT OF FINANCIAL DERIVATIVESTABLE OF CONTENTSPara. Nos.HIGHLIGHTSIBACKGROUND1-7IIOBJECTIVES OF THE AUDIT8IIISCOPE OF AUDIT9IVFINDINGS, RECOMMENDATIONS AND COMMENTS A. Duration10-15B.Relationship Between Duration and Futures Trading16-24C.Portfolio Risk Profile25-39D.Authentication of Trades Data40E.Distribution of Trades41-48Appendices1. Table of Audit Recommendations2. US Dollar Portfolio Duration vs. Futures Transactions3. French Franc Portfolio Duration vs. Futures Transactions4. US Dollar Profit and Loss Analysis5. Japanese Yen Profit and Loss Analysis6. French Franc Profit and Loss Analysis7. Authentication of Trades DataREPORT ON AN AUDIT OF FINANCIAL DERIVATIVESHIGHLIGHTSBACKGROUND1.The Expanded Investment Authority of the Treasurers Department (TD), which was approved by the Asian Development Banks (Bank) Board of Directors on 24 October 1991, allows the Bank to trade exchange-traded financial futures and options contracts for the purpose of managing market risk of the Banks investment portfolio (Portfolio). 2.The Portfolio is maintained primarily as part of the Banks cash flow management process to allow the Bank to continue to function should its borrowing operations be interrupted. Given that the key aim of maintaining the Portfolio is to manage the cash flow of the Bank, more consideration is accorded to the security and liquidity of investments rather than the income they generate. Hence funds are invested to achieve the principal objectives of security and liquidity, and maximising return on the Portfolio is only an ancillary objective. This implies that the primary investment strategy of the Portfolio is minimisation of the Portfolios risk before optimisation of the Portfolios income or return.3.Paragraph 13 of the Expanded Investment Authority document states that the Bank can use financial futures and options contracts to have more control over the market risk of its Portfolio. In line with the Banks investment strategy and Paragraph 13, the Banks key objective of using financial futures and options should therefore be to minimise the risk of the Portfolio rather than to generate income. In other words, the Bank is allowed to use financial futures and options generally as hedging instruments, in contrast for example to an investment bank that might use these for pure trading/speculative purposes, i.e., to enhance the Portfolios return by taking a view on the market.4.The Bank began its financial derivatives trading activities in 1994. The Banks financial derivatives trading activities have been concentrated primarily in interest rate futures contracts. 5.An audit was requested by the Audit Committee of the Board to evaluate whether the derivatives transactions undertaken by the Bank were conducted in accordance with the Banks policy on derivatives trading. The Office of the General Auditor (OGA) engaged KPMG Consulting (Asia Pacific) to assist in this audit (the Audit).6.The objectives of this Audit were to: (i) analyse the hedging activities in financial derivatives; (ii) analyse the derivatives transactions and determine the existence of abnormal trends; and (iii) identify essential and practical risk management measures necessary to mitigate the Banks exposure to risks identified from the above analyses as well as any weaknesses in the existing internal control systems.OVERALL CONCLUSION7.The Audit revealed the following:i. Analyses of the Banks derivatives trading activities showed that the Bank used derivatives mainly for income optimisation rather than to manage the Banks Portfolio Duration, i.e., market risk management. These activities appear somewhat inconsistent with the Banks overall investment strategy, which primary objectives are security and liquidity rather than income generation. Most of the futures trades were extremely short-term in nature or intra-day. These kind of trades are more speculative in nature, and hence, actually increased the Banks market risk exposure as evidenced by the risk analyses conducted on selected Portfolios.ii. The setting of risk limits, i.e., Duration targets, are left too broadly to TD. Management only defines broad Duration band targets. This effectively allows TD to set its own trading and risk limits with little management involvement, which is not “best practice”. Furthermore, the Duration target bands set by TD are too wide, and there is no stop-loss limit established for the Banks derivatives trading activities. iii. There appears to be a concentration of futures trades with one counter-party in the initial years of the Banks futures trading activities, and it is interesting to note that this counterparty is one of the most expensive brokers.RECOMMENDATIONS8.The areas identified for improvement and strengthening may be classified into five categories, i.e. those that will result in better compliance, strengthening internal controls, and improvements in efficiency, economy and effectiveness.No. ofRecommendations1 The total number of recommendations may not tally with the total number of the five categories since one recommendation may fall into more than one category.TotalComplianceInternal ControlEfficiencyEconomyEffectiveness503224The significant recommendations are summarised hereunder. The Bank should:i. review its derivatives trading policy. In particular, the Bank should set out clear objectives for derivatives trading, and communicate these objectives to its portfolio managers.ii. establish clear limit structure for its derivatives trading activities. In the interim, the Bank should set a narrower Duration target band, stop-loss limits, and counterparty trading limits. In the longer term, the Bank should establish risk limits based on VaR.iii. use VaR as a measurement tool for market risk rather than Duration.iv. improve its risk management capabilities to monitor and control its derivatives trading activities by improving its risk management information and procuring an appropriate risk management system to manage the Banks Portfolio market risk.REPORT ON AN AUDIT OF FINANCIAL DERIVATIVESI. BACKGROUND1.The Expanded Investment Authority of the Treasurers Department (TD), approved by the Asian Development Banks (Bank) Board of Directors on 24 October 1991, allows the Bank to trade exchange-traded financial futures and options contracts for the purpose of managing market risk of the Banks investment portfolio (Portfolio). 2.The Banks Portfolio consists of liquid securities so that the Bank can easily liquidate these securities to meet its obligations such as disbursement of loans to developing member countries, servicing the Banks debt and meeting necessary operating expenses. The Portfolio is maintained primarily as part of the Banks cash flow management process to allow the Bank to continue to function should its borrowing operations be interrupted.3.Given that the key aim of maintaining the Portfolio is to manage the cash flow of the Bank, more consideration is accorded to the security and liquidity of investments rather than to income generation. Hence funds are invested to achieve the principal objectives of security and liquidity, and maximising return on the Portfolio is only an ancillary objective. This implies that the primary investment strategy of the Portfolio is minimisation of the Portfolios risk before optimisation of the Portfolios income or return. In order to achieve these objectives, the liquid securities that the Bank invest in are liquid high credit rated fixed income securities such as US government bills or bonds, and short term bank deposits.4.Paragraph 13 of the Expanded Investment Authority states that the Bank can use financial futures and options contracts to have more control over the market risk of its Portfolio. The use of financial futures and options allows the Bank to separate its market risk decision from its security selection decision. In line with the Banks investment strategy and Paragraph 13, the Banks key objective of using financial futures and options should therefore be to minimise the risk of the Portfolio rather than for income generation. In other words, the Bank is allowed to use financial futures and options as hedging instruments, in contrast for example to an investment bank that might use these for pure trading/speculative purposes, i.e., to enhance the Portfolios return by taking a view on the market.5.The Bank began its financial derivatives trading activities in 1994 and these activities are governed by the following policies and guidelines in addition to the Expanded Investment Authority: (i) Investment Guidelines, which was approved by the Banks President on 29 October 1991; (ii) Internal Guidelines for the Use of Exchange-Traded Financial Futures and Options, which was issued by the Investment Division, TD (TDID); and (iii) Operational Guidelines and Procedures for the Settlement and Control of Transactions in Financial Futures and Options, which was also issued by TDID.6.The Banks financial derivatives trading activities have been concentrated primarily in interest rate futures contracts since it started its trading activities. A summary of the financial futures trading activities is given in Table 1.Table 1 Financial Futures Trading ActivitiesYEARNUMBER OF CONTRACTSCONTRACT VALUE (USD)GAIN(LOSS) (USD)199429,9975,295,940,9061,671,881199514,7554,122,303,817(1,192,866)19965,5601,128,614,352(1,092,168)19975,036892,622,449(842,234)19982,894399,604,964(51,291)TOTAL58,24211,839,086,488(1,506,678)7.An audit was requested by the Audit Committee of the Board to evaluate whether the derivatives transactions undertaken by the Bank were conducted in accordance with the Banks policy on derivatives trading. The Office of the General Auditor (OGA) engaged KPMG Consulting (Asia Pacific) to assist in this audit (the Audit).II. OBJECTIVES OF THE AUDIT8.The objectives of this Audit were to:i. Analyse the hedging activities in financial derivatives;ii. Analyse the derivatives transactions and determine the existence of abnormal trends; andiii. Identify essential and practical risk management measures necessary to mitigate the Banks exposure to risks identified from the above analyses as well as any weaknesses in the existing internal control systems.III. SCOPE OF AUDIT9. The Audit reviewed: (i) documentation concerning the Banks derivatives activities, including Board documents, operation policies, procedures and reports; (ii) a sample portfolio of the underlying and derivatives positions of the Bank from 1994 to 1998 to analyse whether the derivatives positions were transacted in accordance with the Banks investment strategy; (iii) prices of the derivatives transactions undertaken; and (iv) trading patterns of the transactions undertaken.IV. FINDINGS, RECOMMENDATIONS AND COMMENTA. Duration10.The Expanded Investment Authority defines market risk of the Banks Portfolio in terms of Duration. This document states that management is required to maintain the Portfolio Duration within a very broad 0-48 month band. This band is shortened further to a Duration of 0-24 months in the Investment Guidelines issued by the President for a long-term position within a currency sub-portfolio. Based on these broad Duration bands, TD sets target Duration for each major currency sub-portfolios on a weekly basis. Given that Duration is used as a market risk measure, the Bank is essentially allowing TD to set its own market risk limits for the Portfolio. 11.To achieve these Duration or market risk targets, TDID can either: (i) change the Portfolio composition by buying and selling securities with different maturity and / or coupons; or (ii) use financial futures and options to change the Portfolios Duration; as the yield curve of the various investments changes.12.Once the Portfolios Duration or market risk target is met based on the Duration target established by TD on a weekly basis, TDID then aims at optimising the Portfolios income. The optimisation strategy may involve using financial futures and options, and any optimisation will aim to maintain the Portfolios Duration or market risk target.13.For consistency with the Banks Portfolio objectives, the main aim of using financial futures and options should be to minimise the Portfolio losses or risk exposures as a result of underlying price movements. In order words, the main aim of TDID using interest rate futures should be to decrease the Banks Portfolio Duration as interest rate rises rather than using interest rate futures as an optimisation of income tool.14.Furthermore, while Duration is a measurement tool used by many fixed-income securities portfolio managers, it is essentially used for hedging applications, immunisation and asset/liability management, and not as a market risk measurement tool. Duration is not an appropriate measurement tool of market risk. Reasons include: (i) its use is only restricted to fixed-income securities; (ii) it only measures price return volatility from interest rate changes rather than total return volatility, i.e., profit and loss; (iii) it is not a very dynamic measurement tool; (iv) it is not predictive; and (v) it does not take into account the effect of portfolio diversification.Comments15.Irrespective of whether Duration is a good measurement tool of market risk, it is not “best practice” to allow the setting of risk limits, i.e., Duration targets, to be left too broadly to TD. The Banks Board of Directors and senior management must be proactively involved in the process of setting up risk limits. Most major G30 regulators expect the Board of Directors or one of its designated members to oversee and steer the overall Risk Management Process of banks under their supervision. This includes the active participation in formulating a Risk Strategy and approves overall and specific risk limits. On a day to day basis the mandate is generally delegated to a member of the Executive Management. The responsibility of managing the overall risks of the bank nevertheless still remains within the Board.B.Relationship between duration and futures trading16.As stated in the Expanded Investment Authority document, fi