Definition
Derivative instrument risk is the risk resulting from the Group’s taking up a position in derivative financial instruments.
Risk management objective
To limit potential losses in respect of changes in factors specific for derivatives (other than foreign exchange rates or interest rates) to acceptable levels by appropriately shaping the structure of positions taken in those instruments.
Risk identification and measurement
For the purpose of managing derivatives risk, the Group uses:
- the Value at Risk (VaR) model;
- analysis of stress tests, taking into account the changes in market prices of the underlying instruments, in their volatility, and in interest rates;
- sensitivity ratios for options.
Risk control
Control over derivatives risk consists of determining derivatives risk limits and thresholds tailored to the complexity of the Group’s operations.
Risk forecasting and monitoring
Monitoring the risk of derivative instruments takes place as part of monitoring of other types of financial and credit risk. The Group places particular emphasis on monitoring the financial risk related to the maintenance of the currency options portfolio and the customer credit risk resulting from amounts due to the Group in respect of derivative instruments.
Reporting
The reports on derivative risk are prepared on a daily, weekly, monthly and quarterly basis.
Management actions
The main tools used in derivative risk management are as follows:
- procedures for derivative risk management;
- limits and threshold of the derivative risk.
- master agreements defining, e.g. settlement mechanisms;
- collateral agreements, under which selected Bank customers are required to establish a collateral on exposures arising from derivative instruments.
The risk is managed by imposing limits on the derivative transactions, monitoring these limits and reporting the level of risk.
The derivative risk management process is integrated with the management of the following types of risk: interest rate, currency, liquidity and credit risk. However, due to the specific nature of derivative instruments, it is subject to specific control specified in the internal regulations of the Bank.