Capital markets

 
SCM is the largest division in the Capital Management cluster. Within SCM, the Asset Liability and Risk Management committee (ALaRMCO) is responsible for the implementation and monitoring of risk management processes to ensure that the risks arising from trading positions are within the approved risk parameters. Risk measurements are calculated through the application of various statistical techniques, including value at risk (VaR), and are measured against pre-approved exposure limits. These risk measurements are supplemented with stress testing and scenario analysis. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established when creating the related models. Sanlam believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. Therefore, such models are tools and inputs in the decision-making process, but do not substitute for the experience or judgement of senior management.

Business-wide risk levels are reported to senior management, while desk risk levels are reported to the relevant trading managers and traders. Limit breaches are escalated for approval in terms of an Approval Framework. The risk information is summarised, reported to, and discussed by the ALaRMCO at weekly meetings.

The mandates for existing businesses are reviewed and submitted for ALaRMCO approval and Risk committee notification on at least an annual basis or more frequently if it was changed through the course of a financial year. An initial mandate development process is undertaken for each new business ventured into by SCM. Based on the business mandates, quantifiable risks are measured and reported on a daily basis. Any new type of business or product is subjected to a comprehensive review process before initiation to ensure that all of the risks associated with new businesses or products have been identified and can be appropriately managed.

SCM is also exposed to credit risk in respect of its working capital assets and loans extended as part of its debt finance and equity structuring activities. Collateral is placed or received for transactions entered into by SCM, including (but not limited to) securities lending and derivative exposures. 
 

1. Market risk

SCM uses VaR to calculate market risk capital. VaR measures the maximum loss over a given horizon with a specified level of confidence. VaR is computed as follows:
 
> At a 99,5% confidence level (to be consistent with SCM's risk appetite relating to SCM's business);
> Over a 10-day holding period (which takes account of market liquidity risk in the VaR calculation through setting the liquidity period at 10 days);
> Multiplied by a factor of three (to allow for uncertainty in estimating VaR at high confidence levels); and
> VaR is calculated on a diversified basis for SCM as a whole and takes the diversification among portfolios into account.
 
Equity risk
Equity price stress tests (including equity instruments and derivatives) are performed on the SCM portfolios. The scenarios used in the stress tests incorporate a combination of equity price movements of between -50% and +20%. In the equity price stress test results, the maximum loss is R2,9 million (2009: R0,4 million).
 
Change in price:
Maximum net loss (R million)
 
31 Dec 2010
31 Dec 2009
-5% to 5%
1,5
0,4
-10% to 10%
2,9
0,0
-15% to 15%
2,0
0,0
-50% to 20%
2,9
0,4
 
Interest rate risk
Various interest rate stress tests are performed on the SCM portfolios. The relative parallel interest rate stress test calculates the market exposure based on interest rate movements of between +50% and -20%, ceteris paribus. The market exposure that was calculated at 31 December for these tests was as follows:
 
Change in yield:
Maximum net loss (R million)
 
31 Dec 2010
31 Dec 2009
10% to -10%
(15)
20% to -20%
(1)
(17)
50% to -20%
(2)
(17)
 

2. Credit risk

For credit risk capital, SCM utilises the concept of unexpected losses. Based on historical default data, one can compute expected losses on a portfolio of credits. Economic principles dictate that a provision should be created for expected losses, although this is not the approach taken from an accounting perspective. An unexpected loss, on the other hand, is the maximum amount over and above the expected loss that SCM could incur over the particular time horizon with a certain level of confidence. In SCM's economic capital model, an unexpected loss over a one-year time horizon at a 99,5% confidence level is used to compute the credit risk capital. This is consistent with the one-year 99,5% VaR used for market risk capital, although market risk capital is computed over a 10-day liquidation period.

At the end of the financial year, SCM's maximum unexpected loss (credit risk capital) was R80,5 million (2009: R89,3 million) based on a 21-day average of the daily economic capital amounts.

Credit spread stress tests are calculated for all instruments sensitive to credit spread changes. The profit or loss from changes in credit spreads on both the assets and funding are calculated in these stress tests. The stress test results are determined as follows: 
 
> The credit ratings for credit assets and funding are deteriorated by 1, 2 and 3 rating notches;
> The impact of these deteriorations on credit spreads are determined with reference to a pre-defined credit spread matrix used in the marked-to-market of both credit assets and funding;
> The changed credit spreads are used to revalue credit assets and funding; and
> The resultant net changes in the valuations of credit assets and funding are seen as the test results.
 
The table below shows the possible effect of a 1, 2 and 3 notch deterioration in credit rating. The total impact on the valuation of the assets is slightly offset by the impact on the valuation of the funding that is used to acquire the positions in the market. The total effect of a 1 notch deterioration is therefore -R46 million (2009: -R37 million).
 
 
31 December 2010
31 December 2009
R million
Assets
Funding
Total
Assets Funding Total
Current Value
5 533
(1 502)
4 031
7 748 (4 263) 3 485
Stress Results 1
(1 Notch)
(51)
5
(46)
(71) 34 (37)
Stress Results 2
(2 Notch)
(82)
10
(72)
(138) 76 (62)
Stress Results 3
(3 Notch)
(114)
14
(100)
(213) 115 (98)
 
Maximum exposure to credit risk
SCM's maximum exposure to credit risk is equivalent to the amounts recognised in the Statement of financial position, as there are no financial guarantees provided to parties outside the Group that is expected to result in an outflow of resources, nor are there any loan commitments provided that are irrevocable over the life of the facility or revocable only in adverse circumstances.

Credit risk exposures are reported on a netted basis, therefore after taking collateral and netting agreements into account. Appropriate haircuts to collateral and add-ons to exposures are implemented in line with the formulated Credit Exposure Quantification policy. Credit risk exposures are mitigated through several measures, including physical collateral (e.g. mortgage bonds) considered on a case-by-case basis; the use of netting agreements; or guarantees issued by third parties.

The credit quality of each class of financial asset that is neither past due nor impaired, has been assessed as acceptable within the parameters used to measure and monitor credit risk, as described above. There are no assets that would have been past due or impaired, had the terms not been renegotiated. 
 
Concentration risk
Management determines concentrations by counterparty, with reference to the proportion of total credit risk capital held in respect of that counterparty compared to the overall credit risk capital of the entire portfolio. The 10 largest contributors to credit risk capital make up 60% (2009: 49%) of total credit risk capital, but only 18% (2009: 15%) of the total exposure. SCM is therefore not exposed to significant concentration risk.
 

3. Liquidity risk

The maximum available facilities of R8,5 billion significantly exceed the amount utilised of R5,8 billion (2009: R5,1 billion), indicating widely available unutilised funding sources. In order to keep commitment fees within the Sanlam Group, facilities are negotiated with Sanlam at market-related terms, before external facilities are sought. Committed facilities granted by SCM were R519 million (2009: R844 million). A significant portion of trading account assets and liabilities is due within one year.