Market risk

Trading portfolios - concentration limits and other controls

The market risk VaR and stress loss limits are the principal portfolio controls on UBS’s exposure to day-to-day movements in market prices, but controls are also applied to prevent any undue risk concentrations, taking into account variations in price volatility and market depth and liquidity. They include controls on exposure to individual market risk factors and to single name issuers (“issuer risk positions).

In the Investment Bank, a comprehensive set of risk factor limits has been established. They are applied to potential losses arising from moves in a wide range of general market risk factors including exchange rates and interest rates, equity indices and credit spreads. The market moves used are broadly consistent with the basis of VaR, i.e. 10 day 99% confidence moves, and they are reviewed annually but may be amended in the interim if the need arises. Limits are set for individual risk factors or groups of highly correlated risk factors, and each limit applies to exposures arising from all trading businesses of the Investment Bank. Separate risk factor limits are set for other Business Groups where they are considered necessary – in our alternative and quantitative investments business in Global Asset Management, for example, a comparable set of concentration limits and guidelines is applied.

Issuer risk is the risk of loss on securities and other obligations in tradable form, arising from credit-related and other “events and, ultimately, default and insolvency of the issuer or obligor. We take a comprehensive approach to measurement, including both debt and equity, not only in physical form but also synthetic positions arising from forwards, options, default swaps and other derivatives. Our measures of issuer risk exposure are generally based on the loss we would expect to incur following an event and therefore take account of different seniority and whether obligations are secured or unsecured. We also track the maximum amount we could lose if all securities of the issuer became worthless. Positions are controlled in the context of the depth and liquidity of the market in which they are traded, and all material positions are kept under constant scrutiny in light of changing market conditions and specific public issuer information.

Exposures arising from security underwriting commitments are subject to the same measures and controls as secondary market positions but the commitments themselves are also subject to control processes. This generally includes review by a commitment committee with representation from the origination and distribution / sales sides of the business, and from risk control and other relevant functions, as well as approval under specific delegated authorities.

As explained on page 65 under Country risk, we include in our measures of country risk all positions for issuers domiciled in countries subject to country ceilings and exposures to stress moves in the currency, interest rate and equity markets of those countries.

In addition to the standard portfolio and concentration limits, we have an array of “operational limits – bespoke limits developed for a specific purpose where the standard portfolio and concentration limits may not provide comprehensive control. They may address concerns about, for example, market depth or liquidity, operational capacity, or exposure to complex products for which valuation parameters may not be observable with consequent difficulties in valuation and risk measurement.

We adopt prudent valuation standards, and apply valuation adjustments where appropriate to reflect expected loss. Valuation adjustments are also made for positions which rely on complex models for valuation or on models incorporating unobservable parameters – for further details see our Financial report 2005, Critical accounting policies and note 29 Fair value of financial instruments. All models used for valuation or which feed risk positions to risk control systems are subject to independent verification by specialist quantitative units within the CRO organization.