67. Derivative instruments risk management

Definition

The risk of derivative instruments is a risk resulting from the Group’s taking up a position in derivative financial instruments.

Management objective

Limiting potential losses in respect of changes in factors specific for derivatives (other than foreign currency rates or interest rates) to acceptable levels by appropriate formation of the structure of positions taken in those instruments.

Risk identification and measurement

For the purpose of managing derivatives risk, the Group uses:

  • the Value at Risk (VaR) model,
  • analyses of stress tests, in consideration of changes in market prices of the base instrument, changes in its volatility, and changes in interest rates,
  • sensitivity ratios of options.

Control

Control over derivatives risk covers determining derivatives risk limits and thresholds tailored to the scale and complexity of the Group’s operations.

Forecasting and monitoring

Monitoring the risk of derivative instruments takes place as part of monitoring of other types of financial and credit risk. The Group puts particular emphasis to monitor financial risk related to the maintenance of currency options portfolio and customer credit risk resulting from amounts due to the Group in respect of derivative instruments.

Reporting

The reports on derivatives risk are developed on a daily, weekly, monthly and quarterly basis.

Management actions

The main tools used in derivative risk management are as follows:

  • written procedures for derivative risk management,
  • limits and thresholds set for the risk related to derivative instruments,
  • master agreements specifying, i.a. settlement mechanisms,
  • collateral agreements, under which selected clients of the Bank are required to establish a collateral on exposures due to derivative instruments.

Risk management is carried out by imposing limits on the derivative instruments, monitoring limits and reporting risk level.

The derivative risk management process is integrated in the Bank with management of the following types of risk: interest rate, currency, liquidity and credit risk. However, due to the specific nature of derivatives it is subject to special control specified in the internal regulations of the Bank.

Methods of derivative risk management in the Group subsidiaries are defined by internal regulations implemented by these entities which take up a position in derivative instruments or plan to take positions in such instruments. These regulations are developed after consultation with the Bank and take into account the recommendations issued by the Bank for the Group entities.

Positions taken by the other Group entities in particular derivative instruments are determined using similar methods to those used for positions taken by the Bank in such derivative instruments, taking into account the specific nature of the business conducted by the Group entities.