Risk concentrations

A concentration of risk exists where: (i) positions in financial instruments are affected by changes in the same risk factor or group of correlated factors; and (ii) the exposure could, in the event of large but plausible adverse developments, result in significant losses.

The identification of risk concentrations necessarily entails judgment regarding potential future developments. This is because such developments cannot be predicted with certainty and may vary from period-to-period. In determining whether a concentration of risk exists, risk controllers consider a number of elements, both individually and in combination. These elements include: the shared characteristics of the instruments; the size of the position; the sensitivity of the position to changes in risk factors and the volatility of those factors; the liquidity of the markets in which the instruments are traded and the availability and effectiveness of hedges or other potential risk mitigants; and the risk-reward profile of the positions.

If a risk concentration is identified, it is assessed to determine whether it should be reduced or the risk should be mitigated, and the available means to do so. Identified concentrations are subject to increased monitoring.

Based on its assessment of the portfolios and asset classes where there is the potential for material loss in a stress scenario relevant to the current environment, UBS believes that the exposures shown in this section can be considered risk concentrations according to this definition.

There is clearly a possibility that material losses could arise on asset classes and positions other than those disclosed in this section, if the correlations that emerge in a stressed environment differ markedly from those envisaged by UBS. The firm has, for example, exposures to other US asset-backed securities (ABSs), US prime mortgages, non-US residential and commercial real estate and mortgages (including the Swiss mortgage market), non-US ABSs, non-US reference-linked note (RLN) programs and structured credit programs, including the Canadian commercial paper restructuring. It is exposed to credit spread and default risk on its fixed income trading inventory, to idiosyncratic risk on both equities and fixed income inventory and to emerging markets country risk in many of its trading activities. It has derivatives transactions and a significant prime services business through which it is exposed to the hedge fund industry. Exposures arise on short positions used to imperfectly hedge overall financial market health which could suffer losses and any losses may not be offset by corresponding gains on the assets hedged. If UBS decided to support a Global Asset Management fund or another investment sponsored by UBS, it might, depending on the facts and circumstances, present risks that could increase to material levels. UBS does not currently foresee the likelihood of material losses on such positions in the near term but the possibility cannot be definitively ruled out.

In the tables in this section, the size of the positions held by UBS is generally expressed as "net exposure", with gross exposures detailed in the footnotes in certain cases. Net exposure for each instrument class represents long positions minus short positions where hedge effectiveness is considered to be high. If, at some future date, hedges are considered to have become ineffective, UBS's net exposures will increase. From an internal risk management perspective, it is necessary to look beyond net exposure and consider important characteristics of the underlying assets and financial instruments - for example factors such as vintages, delinquency rates and credit ratings in the underlying mortgage pools, differences in attachment points, timing of cash flows and control rights in the securities held, and basis risks and counterparty risk associated with the hedges.

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