VaR is a valuable risk measure but it should be used in the context of its limitations, for example: • VaR uses historical data to estimate future events, which limits its forecasting abilities;
• it does not provide information on losses beyond the selected confidence level; and
• it assumes that all positions can be liquidated during the holding period used for VaR calculation.
The Bank continuously improves its VaR methodologies and incorporates new risk measures in line with market conventions, industry best practices, and regulatory requirements.
To mitigate some of the shortcomings of VaR, the Bank uses additional metrics designed for risk management and capital purposes. These include Stressed VaR, IRC, Stress Testing Framework, as well as limits based on the sensitivity to various market risk factors.
Calculating Stressed VaR
In addition to VaR, the Bank also calculates Stressed VaR, which includes Stressed GMR and Stressed IDSR. Stressed VaR is designed to measure the adverse impact that potential changes in market rates and prices could have on the value of a portfolio over a specified period
T ABLE 50 PORTFOLIO MARKET RISK MEASURES (millions of Canadian dollars) As at Average
Interest rate risk Credit spread risk Equity risk
Foreign exchange risk Commodity risk
Idiosyncratic debt specific risk Diversification effect1
Total Value-at-Risk (one-day) Stressed Value-at-Risk (one-day)
Incremental Risk Capital Charge (one-year) 1
8.4 8.6 3.2 2.1
High
$ 10.1 $ 10.8 $ 21.9 7.2 5.9 2.7 1.1
13.5 (22.4) 240.6
The aggregate VaR is less than the sum of the VaR of the different risk types due to risk offsets resulting from portfolio diversification.
Average VaR was relatively unchanged compared to the prior year, reflecting a combination of changes in risk positions and market rates. The year-over-year average Stressed VaR increase was mostly driven by equity positions. The average IRC declined by $40.6 million over the year due to changes in U.S. Agency positions.
Validation of VaR Model
The Bank uses a back-testing process to compare the actual and theoretical profit and losses to VaR to ensure that they are consistent with the statistical results of the VaR model. The theoretical profit or loss is generated using the daily price movements on the assumption that there is no change in the composition of the portfolio. Validation of the IRC model must follow a different approach since the one-year horizon and 99.9% confidence level preclude standard back-testing techniques. Instead, key parameters of the IRC model such as transition and correlation matrices are subject to independent validation by benchmarking against external study results or through analysis using internal or external data.
Stress Testing
The Bank’s trading business is subject to an overall global stress test limit. In addition, global businesses have stress test limits, and each broad risk class has an overall stress test threshold. Stress scenarios are designed to model extreme economic events, replicate worst-case historical experiences, or introduce severe but plausible hypothetical changes in key market risk factors. The stress testing program includes scenarios developed using actual historical market data during periods of market disruption, in addition to hypothetical scenarios developed by Risk Management. The events the Bank has modeled include the 1987 equity market crash, the 1998 Russian debt default crisis, the aftermath of September 11, 2001, the 2007 ABCP crisis, and the credit crisis of Fall 2008.
84 TD BANK GROUP ANNUAL REPORT 2016 MANAGEMENT’S DISCUSSION AND ANALYSIS 2 12.7 (25.3) 34.8 205.8
$ 18.1 $ 20.5 $ 33.8 32.8
15.6 11.2 7.4 4.2
22.6 n/m2
43.6 287.9
2016 Low
As at
7.9 9.8 4.9 1.5
Average
7.8 9.0 3.8 1.5
High
11.8 13.5 9
2015 Low
$ 5.4 $ 8.4 $ 8.0 $ 14.9 $ 3.8 5.1 3.5 1.4 1
3.3 7.9 n/m2 144.9 12.9 (26.5) 18.3 255.4 15.9 (25.3)
$ 11.7 $ 18.9 $ 20.7 $ 21.6
28.8 246.4 22.5 n/m2 35.1 319.6
26 $ 15.3 18.3
164.5
Not meaningful. It is not meaningful to compute a diversification effect because the high and low may occur on different days for different risk types.
Stress tests are produced and reviewed regularly with the Market Risk Control Committee.
MARKET RISK IN OTHER WHOLESALE BANKING ACTIVITIES The Bank is also exposed to market risk arising from a legacy portfolio of bonds and preferred shares held in TD Securities and in its remaining merchant banking investments. Risk Management reviews and approves policies and procedures, which are established to monitor, measure, and mitigate these risks.
Asset/Liability Management
Asset/liability management deals with managing the market risks of TD’s traditional banking activities. Such market risks primarily include interest rate risk and foreign exchange risk.
WHO IS RESPONSIBLE FOR ASSET/LIABILITY MANAGEMENT TBSM measures and manages the market risks of the Bank’s non-trading banking activities, with oversight from the Asset/Liability and Capital Committee, which is chaired by the Group Head and CFO, and includes other senior executives. The Market Risk Control function provides independent oversight, governance, and control over these market risks. The Risk Committee periodically reviews and approves key asset/ liability management and non-trading market risk policies and receives reports on compliance with approved risk limits.
4.6 4
1.1 0.8
12.6 n/m2
of stressed market conditions. Stressed VaR is determined using similar techniques and assumptions in GMR and IDSR VaR. However, instead of using the most recent 259 trading days (one year), the Bank uses a selected year of stressed market conditions. In the fourth quarter of fiscal 2016, Stressed VaR was calculated using the one-year period that began on February 1, 2008. The appropriate historical one-year period to use for Stressed VaR is determined on a quarterly basis. Stressed VaR is a part of regulatory capital requirements.
Calculating the Incremental Risk Charge
The IRC is applied to all instruments in the trading book subject to migration and default risk. Migration risk represents the risk of changes in the credit ratings of the Bank’s exposures. TD applies a Monte Carlo simulation with a one-year horizon and a 99.9% confidence level to determine IRC, which is consistent with regulatory requirements. IRC is based on a “constant level of risk” assumption, which requires banks to assign a liquidity horizon to positions that are subject to IRC. IRC is a part of regulatory capital requirements.
The following table presents the end of year, average, high, and low usage of TD’s portfolio metrics.
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