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Exposure Analysis Explained

There are two main components to meaningful exposure analysis:

1. Considering the different roles a financial institution can play
2. Accurately reflecting the effect of notional-based derivatives holdings

These can be addressed separately as each piece provides valuable information on its own, but combining them tells a more complete story.

Roles

Companies and other legal entities can play multiple roles in relation to a transaction. One of the main roles for equity and fixed income securities is that of an issuer. Bankruptcy of an issuer can mean partial or full loss of capital invested in the security. This is commonly referred to as issuer exposure.

For over-the-counter (OTC) securities, the institution on the opposite side of a transaction is the counterparty. This is equivalent to the issuer relationship for equity or fixed income securities, as bankruptcy of a counterparty can also result in partial or full loss of capital invested in the trade. This is commonly referred to as counterparty exposure.

Institutions can also be brokers to settle trade proceeds and/or clearing brokers to settle variation margin. In the intertwined world of financial markets, the same institution can (and often does) play multiple roles for different securities held in the same fund. This makes it critical to have a holistic view of exposure reporting.

Derivatives

Most derivatives are based on notional value rather than true principal value like equities and fixed income, and many are structured to have zero net present value (NPV) at trade time. This results in market values (MVs) that are often vastly smaller than a security's notional value. The MVs flow through to exposure/holdings and performance reports in a way that is mathematically accurate, but it significantly understates the true exposure and misrepresents the true security-level performance. When building lot-level reports to reflect counterparty exposure for derivatives, the MV that is used for accounting will be reflected.

For single-leg derivatives such as future contracts, option contracts, and CDS/CDX, the solution is to include a security's notional in its MV, while creating a synthetic cash security that offsets the full notional value. For multi-leg derivatives such as interest rate swaps (IRS) and total return swaps (TRS), the solution is to move the MV from the contract to the receive leg (again including its notional), and use the the pay leg as the offset.

Manipulating values for synthetic cash and the legs of a swaps is accomplished using Eagle Enrichment. This is a standalone tool in Data Management that runs at the position level after the S2P push, once holdings and cash activity data have been populated. Running at the lot level is not supported. It can also be used for activity loaded directly into Data Management by clients who do not use Eagle Accounting, but the rules were built assuming data would be in the locations supplied by S2P. If you do not use Eagle Accounting, you must either ensure your data is loaded to the same locations, or adjust the rules to accommodate your unique data structure.

Instrument Engineering provides standard rules for future contracts, option contracts, and several flavors of swaps as part of the package content, and we are always working to add support for additional derivative types. The standard rules are attached to Instrument Engineering's best practices documents for each supported security. You are able to customize these rules and add your own if the package content does not meet your needs.

Eagle Enrichment

Eagle Enrichment can be implemented if exposure-based analyses are required, but it can only access and write position-level data (POSITION_DETAIL, for example); it cannot access or write lot-level data (LOT_LEVEL_POSITION_DETAIL). Lot-level data, which includes information enters at trade time, cannot be merged with position-level data using standard Eagle reporting at this time. This prevents you from using enriched data on lot-level counterparty reports. There are two options if notional-based analyses are required at the counterparty level:

• For all securities, populate Issuer (2299) with the institution that carries the counterparty exposure, then group enriched position-level reports by Issuer
• Run both the position- and lot-level reports, then cross-reference the enriched values from the position-level report to the lot-level counterparty report

Standard Eagle Enrichment rules for Eagle Accounting users are available for the following instrument types: futures, options, CDX, CDX, interest rate swaps (IRS, V15 R2.29), and total return swaps (TRS). The .egl rule files are available in the corresponding best practices for each of these instrument types. Data that is generated through Eagle Enrichment is stored under a separate source (EAGLE ENRICHMENT by default) that does not effect the raw accounting data. This alternate source can then be used for reporting.

IMPLEMENTATION

There are two options for modeling derivatives traded with multiple counterparties: security level and trade level. Consider the example of CDX.A traded with both Counterparty X and Counterparty Y.

• Security Level: in this model, a counterparty is viewed as a security-level attribute and you maintain a separate version of the security for each counterparty
  • Following the initial example:
    • Two separate security master files (SMFs) are set up for CDX.A, one with Issuer = Counterparty X and one with Issuer = Counterparty Y
  • This model allows both position- and lot-level exposure reporting, as the issuer will be the same across lots
    • Eagle Enrichment can be used for position-level reporting
• Trade Level: in this model, a counterparty is viewed as a trade-level attribute and you maintain a single version of the security regardless of how many counterparties it's traded against
  • Following the initial example:
    • A single SMF is set up for CDX.A
    • Issuer X and Issuer Y are set with Counterparty = Yes to make them available as counterparties
    • Counterparty is set to Counterparty X and Counterparty Y on their respective trades
  • This model requires lot-level exposure reporting, as counterparties will be different across lots
    • Eagle Enrichment cannot be used for lot-level reporting 

EXPOSURE REPORTS

MV-Based

S2P can transfer data at both the position and lot levels to Data Management. This is controlled by STAR Data Filter (2283). Because some OTC securities can be traded with multiple counterparties, there may be requirements do MV-based exposure reporting at the lot level. However, Eagle Enrichment is only performed at the position level. You must build your exposure-based reports at the position level if you want to use Eagle Enrichent to calculate notional market values.

Note: S2P does not include CASH securities in the lot-level push. As such, any lot-level reports will be missing the cash position(s). If this a problem, a custom exporter can be implemented to copy CASH positions from the position-level tables to the lot-level tables.

General Reporting (Eagle OLAP)

OLAP reporting has rich features to create customized lot-level exposure reports. The table below contains some key Field Attributes that can be used for these reports, but you will likely want to add other fields to meet your specific needs. For step-by-step instructions on creating an OLAP report, please refer to the General Reporting Reference Guide. Lot-level exposure reports cannot include data from Eagle Enrichment because it is only available at the position level.

IF Investment Type IN (EQ, FI, FT, OP)
THEN Issuer
ELSE IF Investment Type IN (DERV, FWD)
THEN Counterparty
END IF

Notional-Based

As discussed earlier, a derivative's MV is typically not a very accurate measure of the true exposure provided by the security. To build position-level notional-based exposure reports, you must implement Eagle Enrichment to generate notional market values for derivatives. One of the benefits is that data is published to the same locations as S2P, except under a different source (EAGLE ENRICHMENT). This means you do not necessarily need to change the Field Attributes used in your reports when doing notional-based analyses. Instead, you have two options:

1. Duplicate the MV-based report and change the Source Rule to only use the EAGLE ENRICHMENT source
   • With this method, any securities that are enriched will have null values on the report
   • You may also choose to run all of your holdings through Eagle Enrichment, which will copy over the the regular MVs to the EAGLE ENRICHMENT source for securities that do not not require a separate notional-based calculation
     • In this case you can have dedicated reports using the EAGLE ENRICHMENT source that still include data across all security types
2. Edit the existing Source Rule of your report to have EAGLE ENRICHMENT take priority
   • With this method, securities that were not enriched Eagle Enrichment will still show their original values on the report
   • This allows you to pull enriched data for some securities alongside original data for other securities
     • The downside is it may not be obvious when there was a problem with Eagle Enrichment based on looking at a report, because the original data will still be displayed even if a security was supposed to be enriched