Risk Management and Control

Market risk is incurred primarily through UBS’s trading operations, which are mainly in the Investment Bank, with limited activity in the wealth management and asset management businesses. Additionally, our Treasury department assumes market risk as a result of its balance sheet and capital management responsibilities.

Market risk for the Investment Bank, as measured by the average 10-day 99% Value at Risk (VaR), fell to CHF 315 million in fourth quarter from CHF 343 million in third quarter, while quarter-end VaR was higher at CHF 355 million compared to CHF 309 million at the end of third quarter.

The difference in period-end VaR was driven by equities risk, which increased from mid-quarter onwards. Both average and period-end VaR for equities were up from third quarter, the average to CHF 221 million from CHF 198 million and quarter-end to CHF 235 million from CHF 193 million. Much of this increase was a response to good trading conditions – greater market volatility towards the end of the quarter, increases in major indices, many of which reached annual highs during the period, heavy trading volumes, and strong new issuance and merger and acquisition activity.

Interest rate risk remained a significant contributor to VaR, credit spread exposure being the dominant component. Changes in exposure to the overall level of interest rates and associated portfolio effects led to fluctuations during the quarter and to a reduction in average interest rate VaR which was down to CHF 302 million from CHF 365 million. Quarter-end interest rate VaR fell to CHF 269 million from CHF 363 million compared to third quarter, reflecting uncertainty about the longer-term trend of interest rates.

Market risk for UBS as a whole followed Investment Bank VaR. Average VaR was lower at CHF 334 million from CHF 367 million in third quarter, while quarter-end VaR increased to CHF 373 million from CHF 326 million at the end of the previous quarter.

‘Backtesting’ compares the 1-day VaR calculated on positions at the close of each business day, with the actual revenues arising on those positions on the next business day (excluding intraday trading revenues, fees and commissions). It is used to monitor the quality of the VaR model. The graph below shows these revenues and the corresponding 1-day VaR over the last 12 months. The 10-day VaR, which is the basis of the limits and exposures in the Investment Bank table to the right, is also shown in this graph for information. Revenue volatility over the period was within the range predicted by the VaR model.

We also routinely assess and actively manage and control tail risks against a standard set of stress scenarios, supplemented by specific scenarios concentrating on individual sectors or reflecting current concerns, such as widening credit spreads or increased energy market volatility. Stress events modeled in our standard scenarios include crises in equity, corporate bond and emerging markets, and severe movements in currency, interest rate and energy markets. These scenarios are reviewed regularly and fine-tuned as necessary. Both period-end and average stress loss exposure were higher than in third quarter.

VaR and stress measures control our overall portfolio exposure but we also apply concentration controls on exposure to individual market risk variables, such as individual equity markets, individual currency interest and foreign exchange rates, and single name issuers. The diversification of risks and avoidance of undue concentrations remain key pillars of our risk control process.