Canadian Annual Derivatives Conference 2005

1. Canadian Annual Derivatives Conference2005 Bruce Rutherford Managing Director Capital Markets Risk Assessment Services (CMRAS)

2. Agenda • Who are we and what do we do? • OSFI • Capital Markets Risk Assessment Services • Derivatives • Our views • Impact on our work • Who are we and what do we do? • OSFI • Capital Markets Risk Assessment Services Page 2 / 13

3. Who are we? OSFI is the primary regulator of: • Federal Regulated Financial Institutions • Deposit Taking Institutions (142) • Insurance Companies (302) • Private Pension Plans • More than 1000 Page 3 / 13

4. OSFI’s mandate • Safeguard policyholders, depositors and pension plan members from undue loss • Maintain public confidence in the financial system Page 4 / 13

5. OSFI activities • Regulation • Develop and interpret legislation and regulations • Issue guidelines • Approve requests • Supervision • Assess safety and soundness • Intervene in a timely manner Page 5 / 13

6. CMRAS activities Review trading and treasury operations • Assess financial institutions' risk • Market and associated operational risks • Assess risk management practices Review and approve internal models • Assess risk and valuation models • Approve VaR models for market risk regulatory capital Policy consultation • Develop and comment on domestic and international policy, e.g. Basel II • Develop and interpret guidelines • Transaction analysis Page 6 / 13

7. Agenda • Who are we and what do we do? • OSFI • Capital Markets Risk Assessment Services • Derivatives • Our view • Impact on our work • Derivatives • Our views • Impact on our work Page 7 / 13

8. Derivatives – Various views Unfavourable • Derivatives are time bombs, both for the parties that deal in them and the economic system • Large amounts of risk are concentrated in the hand of few derivative dealers Favourable • Derivative are effective risk management tools • Derivatives have improved economic stability • Benefits have materially exceeded the costs Our view: Derivatives are neither good nor bad… Page 8 / 13

9. Post-trading processes (Feedback) • P&L reporting • Risk reporting • Problem reporting • Trading processes (Actions) • Trader supervision • Risk measurement (VaR, Greeks, Stress testing) • Supporting operational processes (e.g., Price verification, Deal confirmations) Derivatives – Our review framework • Pre-trading processes (Intent) • Business planning • Trading strategies • Risk appetite Page 9 / 13

10. New Risks • Credit correlation • Model risk • Infrastructure • Reputational risk • Systemic risk Derivatives – Impact on risks • Risk migration/substitution Traditional Risks • Credit spread • Credit default • Interest rate • FX • Equity • Traditional risks are better understood and more transparent Page 10 / 13

11. Post-trading processes (Feedback) • P&L reporting • Risk reporting • Problem reporting • Trading processes (Actions) • Traders supervision • Risk measurement (VaR, Greeks, Stress Testing) • Supporting operational processes (e.g., Price verification, Deal confirmation) Derivatives – Our review framework • Pre-trading processes (Intent) • Business planning • Trading strategies • Risk appetite • New product approval • Reputational risk review • P&L explanation • Process sign-offs • Deal capture (exotic/structured products) • Model risk • Systems integration Page 11 / 13

12. Takeaways • From our viewpoint, derivatives are not inherently good nor bad; what matters is how they are used • Increasing complexity of derivatives impacts: • Types of risk institutions are exposed to • Our supervisory review framework • In the current dynamic regulatory environment, we are involved in: • Development of international guidance • Interpretation and application to Canadian banking industry Page 12 / 13

13. Questions? Bruce.Rutherford@osfi-bsif.gc.ca Keith.Isaac@osfi-bsif.gc.ca Page 13 / 13