3.1 All financial intermediaries, regulated and unregulated, should move in the direction of publicly disclosing periodic quantitative information which expresses, in summary form, the estimates relied upon by firm management of:

• the market risks in the relevant portfolio or portfolios, as well as the firm’s actual performance in managing the market risks in these portfolios.

3.2 This recommendation suggests that firms move in the direction of drawing from their risk management information systems for their public disclosures. Firms could meet the principle by disclosing (summary) information about risks and performance using whatever methods are employed in their risk management systems, and covering whatever portions of the firm that are spanned by their risk management systems. Many firms may not yet have sophisticated risk management information systems that cover the entire firm. Nevertheless, firms should draw on the information used by management about the parts of the firm or the portfolios for which risk management systems exist.

3.b Quantitative information

3.3 Quantitative information about risk exposures and risk management performance can provide a framework for qualitative description and assessment. While qualitative information about risk management and risk control practices is useful and should be an integral component of disclosure, it is not a substitute for quantitative information. Qualitative information or discussion of risk management activity can become meaningless boiler-plate if it is not linked to quantitative data about risks and realized outcomes. Quantitative measures of risk and the impact of market prices on portfolio values are now used internally by many firms, and for that reason should be used as the basis for firms' disclosures about their risks. Quantitative disclosures about a firm's risks as they are viewed by the firm's management are likely to be informative because they will conform to the specific circumstances of the firm's risk profile and approach to managing those risks. ^l

3.c Risk management information systems

3.5 Risk management concepts and practices developed by financial institutions provide useful ways of organising and presenting information about financial risks, and disclosure practices would benefit from adopting such risk management concepts. The use of risk management information systems as the source of disclosures also has the benefit of allowing disclosures to evolve with these systems. While a divergence of views exists at the level of specific computation methods and assumptions, risk measurement and management as practised by market participants do have common features. Such features include: (1) a portfolio approach; (2) a focus on basic types of risk (e.g. interest rate risk, exchange rate risk, or credit risk), rather than on instruments or balance sheet categories; (3) a measure of the value of the portfolio that reflects current market prices, interest rates, and exchange rates; and (4) a measure of the sensitivity of the portfolio's value to changes in these prices. Drawing on these features, disclosures consistent with the recommendation would take a portfolio perspective and would include measures of the portfolio's performance and risks that are based on market prices.

3.6 Disclosures of information from risk management systems need not be provided at the level of detail that would reveal proprietary information. Where the coverage of the systems are broad, managers, who are aware of what information is proprietary, should be able to find ways to aggregate information into summary statistics that allow outsiders to evaluate a firm’s risk and performance and yet do not reveal the firm’s trading positions. Where systems coverage is partial, it may be that, even after aggregation, proprietary trading strategies could still be revealed. In such cases, firms should explore alliterative measures that would not reveal proprietary information. However, the fact that the information disclosed would involve an institution's past rather than current trading activities should, in general, mitigate the sensitivity of any information revealed.

3.d The relevant portfolio

3.7 Disclosures about risks and the management of those risks will be most meaningful if they are made from a portfolio perspective. Such an approach is necessary because exposures ‘to a particular type of financial risk (e.g. exchange rate risk) can arise from a variety of financial instruments or balance sheet categories. Hence, a portfolio approach that takes account of all sources of exposure to that particular risk (in the portfolio) is necessary. For example, financial derivatives should not be looked at in isolation from the rest of a firm's assets and liabilities. Financial derivatives have risks that are varied but at the same time are also similar or related to risks of traditional assets and liabilities. Hence, separate disclosures of risk exposures arising only from financial derivatives are misleading.

3.8 Ideally, the portfolio about which disclosures are made should be the consolidated portfolio describing the exposures of the entire firm. For example, some firms, in managing a structural exposure (e.g. asset/liability maturity mismatch) might choose to only partially hedge such exposures. Such partial hedging strategies can have exposures similar to trading positions and disclosures should include such exposures. However, firms are organised and managed along different lines and for some firms disclosure of a single firm-wide consolidated portfolio may be neither practical nor meaningful For this reason, disclosures could be organised along lines determined by a firm's management and organisational structure.

3.9 At a minimum, the portfolios whose risks should be disclosed would include the trading portfolio and all other exposures whose risks are managed within the trading account. In practice, however, not all "trading" activity always occurs in the trading account, and such activity should be included in disclosures .²

3.e Measures of risks and performance

3.10 Disclosure of risk management information need not involve all the details, parameters and assumptions that are used internally, but information in aggregate or summary form can still be meaningful. Drawing on the approach taken by firms in their risk management systems for market risks, the quantitative disclosures envisioned in this paper would have two basic components: for the relevant portfolio(s), (i) a measure of the size and variability of the portfolio's riskiness, and (ii) a measure of the size and volatility of the changes in portfolio market value.

(i) Portfolio risks 3.11 One method of measuring market risk exposure that is becoming widely used is value-at-risk an estimate of potential changes in portfolio value based on a statistical confidence interval of changes in market prices that are likely to occur some proportion of the time. (Additional discussion of value-at-risk appears in the Appendix.) An estimate of riskiness, however, should not be interpreted as a projection or forecast. In addition, a statistical measure of risk such as value-at-risk should not be interpreted as a risk limit. Instead, by construction, it is a measure of likely declines in portfolio value that will be exceeded some proportion of the time, even in a perfectly well managed portfolio. ³

3.12 Value-at-risk is one way of measuring risk, and, even though it is becoming more widely used, other approaches are also used by market participants. Disclosures might include elements of market risk assessment methodologies developed by supervisors of financial institutions for prudential purposes. Moreover, in the future other measures of risk might also be developed. Market participants should be encouraged to develop more meaningful ways of communicating risks. Until consensus on "best practice" for conveying risk profiles emerges, the guiding principle should be that disclosures reflect the risks as measured by the firm and presented in a way that allows outsiders to assess the firm's risk management capacity.

(ii) Portfolio performance 3.13 The depiction of portfolio performance should reflect the effects of changes in market prices, interest rates, and exchange rates on the value of the portfolio. Market or present values provide meaningful information for performance assessment because they are observable (present values are computable in standardised ways) and are also independent of management assumptions. One method that is becoming a standard tool of risk management practice is the use of market values. If market valuation is used by a firm in the risk management of the relevant portfolio, then the disclosure of performance could be based on the portfolio market value, and the change in that value due to changes in market prices.

3.14 Examples of market risk disclosures are provided in the Appendix.

Footnotes:

1. The link between quantitative and qualitative disclosures could be strengthened by reference to risk management guidelines such as those developed by the Group of Thirty and by supervisory authorities such as the Basle Committee and the Technical Committee of the Intentional Organization of Securities Commissions.

2. Structured debt securities whose returns are linked to prices of underlying assets are similar to trading positions and should be reflected in the disclosures. For example, a treasurer or fund manager can use structured debt instruments to acquire option-like exposures to exchange rate, interest rate, equity, or commodity risks.

3. An inference that risk management is inadequate would be supportable only when the frequency at which losses exceed the value-at-risk is significantly higher than the confidence level of the value-at-risk (assuming stationary distributions).