Market risk developments - trading

The year in general was one of positive investor sentiment with equity markets in particular performing strongly on the back of excellent corporate earnings. The more buoyant markets supported high trading volumes with strong new issuance and merger and acquisition activity. Despite short term rate hikes during 2005, long-term rates throughout much of the world finished the year at low levels. In currency markets, the US dollar appreciated against other major currencies, but the expectation of a slowdown in growth in 2006 halted the trend towards the end of the year. Higher energy and commodity prices and concerns in the US automotive industry in the spring, and the damage caused by the unusually severe hurricane season in the autumn resulted in periods of market volatility.

Market risk for the Investment Bank, as measured by 10-day 99% confidence VaR, ended the year at CHF 355 million and averaged CHF 346 million for 2005, a slight increase on the 2004 year-end value of CHF 332 million but slightly below the 2004 average of CHF 358 million. The rise in period-end VaR was driven by the increase in our equities risk, but it was the increased diversification between the risk types which led to the reduction in average Investment Bank VaR.

Equities risk in particular increased year on year, ending the year at CHF 235 million, compared to CHF 126 million at the end of 2004. The average, at CHF 173 million, was also up on CHF 153 million for 2004. Much of this increase was a response to good trading conditions, particularly in the latter part of the year – greater market volatility, increases in major indices, many of which reached annual highs in fourth quarter, heavy trading volumes, and strong new issuance and merger and acquisition activity. We were able to capitalize on these conditions in both client business and proprietary trading.

Credit spread exposures remained the dominant element of interest rate VaR, but fluctuations in the level of risk throughout the year were driven by our outright interest rate exposures. These exposures varied in both amount and direction over the year as we actively managed our risk in response to market conditions. Interest rate VaR ended the year at CHF 269 million, a significant decrease on the 2004 year-end VaR of CHF 361 million, reflecting uncertainty about the longer term trend of interest rates. The average of CHF 364 million was up from CHF 340 million in 2004.

Average Corporate Center VaR for 2005 was CHF 63 million, an increase on the 2004 average of CHF 47 million. This resulted from increased interest rate exposure in the Treasury book, but Corporate Center’s contribution to total UBS VaR remained relatively small. Market risk positions in the other Business Groups have only a marginal impact on the total UBS VaR, as can be seen from the middle table on the right.

In third quarter this year, our Wealth Management & Business Banking and Wealth Management US businesses were combined and the municipal securities business of Wealth Management US was transferred to the Investment Bank. The VaR exposures shown in the tables above have been restated to reflect these changes. The exposure for Global Wealth Management & Business Banking includes all the businesses of Wealth Management US for 2004 but for 2005 excludes the municipal securities business. This business is included in VaR for the Investment Bank from 1 January 2005, but its impact on total VaR and interest rate VaR of the Investment Bank was not material.

Stress loss for the Investment Bank, defined as the worst-case outcome from our standard scenarios, ended 2005 virtually unchanged from the end of 2004, and remained well within the approved limit throughout the year. As with VaR, our credit spread exposures remained the dominant contributor, but fluctuations in the level of stress loss exposure during the year were significantly impacted by the varying level of option risk in the equity portfolio.

As for the seven preceding years, UBS had no regulatory backtesting exceptions in 2005. The graph on the next page shows 1-day VaR for portfolios subject to a market risk regulatory capital charge and the corresponding backtesting revenues. The 10-day VaR, which is the basis of the limits and utilizations shown above, is also provided for information. In the histogram on the next page we show backtesting revenues alongside the daily “full revenues from all sources in the Investment Bank.