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Chapter 1
Risk Management for Sovereign Debt
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Chapter 1
Risk Management for Sovereign Debt
1.1
Introduction ......................................................................................................1-5
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
Organization Structure
1.10
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Chapter 1
Risk Management for Sovereign Debt
1.1
Introduction
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1.2.1.1
1.3
Classes of Risk
Frank Knight, Risk, Uncertainty and Prot, 1921 republished in Midway Reprint, Chicago:
The University of Chicago Press, 1985.
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The word crisis implies a special or infrequent condition. Financial crises associated with sovereign debt in the 1980s
and 1990s were by no means infrequent, however.
Paul Sullivan when he was director of Strategic and Risk Management for the National Treasury Management Agency of
the Republic of Ireland, said, all benchmarks should carry a government health warning.
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This measure of risk, the currency-by-currency net difference between sources available to service debt and debt service
payments owed, is illustrated by the denition of a sovereign debt crisis: when the sovereign has insufcient funds to
supply or to purchase the currency needed for a debt service payment.
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Table 1
Sovereign Goal and Policy Guidelines
Example of Public Statement of Goal for Sovereign Debt Management:
To provide the required funding volume in a scal year, in an orderly way that does not
compromise the ability to do that again in the coming year, and at lowest cost consistent with
guidelines and policies.
(1) Funding operations would be conducted within risk tolerances as dened by policy
guidelines. (Guidelines would be specied.)
(2) Funding operations would be subject to macro-economic considerations established by
policies with regard to cyclical stability and domestic market development. (Policies would
be specied.)
Example of Internal Guidelines for Risk Tolerances:
Subject to remaining within [specific tolerance range] of policy/risk management limits for:
(a) the currency composition of future debt servicing requirements over the medium term
horizon
(b) the interest rate resetting pattern over the coming [ve] years
(c) the overall annual debt amortization prole over the coming [ve] years; and
Other [specied in detail] considerations, as established by risk tolerances and other
macroeconomic objectives, such as:
(a) using instrument designs and marketing procedures that enhance liquidity and
marketability
(b) limiting credit risk exposure [with respect both to volume and minimum credit rating],
especially with regard to external entities
(c) using settlement and internal operating procedures that limit exposure to operational
risks.
Example of Policies for Macroeconomic Considerations:
Subject to [specied approaches] to funding so that it is consistent with offering debt regularly
and predictably in order to:
(a) enhance primary and secondary markets
(b) maintain market liquidity
(c) maintain the risk free status of sovereign obligations
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1.7
Optimal Bank Supervision in a Changing World by Alan Greenspan, The Declining? Role of Banking May 1994,
Thirtieth Annual Conference on Bank Structure and Competition, Chicago Federal Reserve Bank.
A Survey of Stress Tests and Current Practice at Major Financial Institutions: report by a Task Force established by
the Committee on the Global Financial System of the Central Banks of the Group of Ten Countries, April 2001. Bank
for International Settlements. available at www.bis.org. Forum for Central Banks, Committee on the Global Financial
System.)
Stress Testing by Large Financial Institutions: Current Practice and Aggregation Issues, April 2000, Committee on the
Global Financial System, Bank for International Settlements, Basel, Switzerland (available on www.bis.org. Forum for
Central Banks, Committee on the Global Financial System.)
Standard of Practice on Dynamic Solvency Testing for Life Insurance Companies, Canadian Institute of Actuaries, June
1991. available at www.actuaires.ca.
Bank for International Settlements release, May 21,1996, Basel Committee/IOSCO Ensuring that Banks Have Adequate
Capital. www.bis.org.
A Universal Approach to Credit Analysis. Moodys Investors Services at www.moodys.com.
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1.8
A Structured Approach to
Organization and Information
Architecture
From Information Systems Planning Guide, which offers assistance to teams conducting a Business Systems Planning
study, copyright International Business Machines Corporation (IBM), Third Edition, July 1981. This approach was used
initially in the 1960s for internal corporate business planning at IBM. It has been rened and used successfully among
a wide group of entities. By now, many professional practitioners in strategic information planning and information
engineering use procedures emanating from this original approach and an extensive literature is available.
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2.
3.
4.
5.
6.
The compilation of the results of these openended interviews produces output including:
1.
Mission statement.
2.
3.
4.
5.
6.
7.
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1.9
Organization Structure
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1.9.1
Organizational Structures to
Limit Portfolio Operational Risk
For example, see documents available from the U.S. Board of Governors of the Federal Reserve System at
www.federalreserve.gov. Supervision Manuals (1) Bank Holding Company, (2) Commercial Bank Examination Manual,
and (3) Trading and Capital-Market Activities. Another source is the Bank for International Settlements in Basel, whose
web site www.bis.org lists many publications, especially those from the Committee on Bank Supervision and Regulation.
Basel Committee on Banking Supervision, Sound Practices for the Management and Supervision of Operational Risk,
February, 2003. Bank for International Settlements, Basle, Switzerland.
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Table 2
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Table 3
Principles for Sound Practices for Managing and Supervising Operational Risk
1.
Approve and periodically review the operational risk management framework. It should have a
wide denition of operational risk and lay down the principles of how operational risk is to be
identied, assessed, monitored, and controlled/mitigated.
Ensure that the operational risk management framework is subject to effective and
comprehensive internal audit by operationally independent, appropriately trained and
competent staff. The internal audit function should not be directly responsible for operational
risk management.
2.
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Monitor performance
1.9.2
Functions
Policymaking
Planning and Program Management
Transacting Borrowings
Cash Management
Risk Management
Analysis
Legal
Operations and Controls
Accounting
Budgeting
Auditing
Business Processes
Develop policies
Authorize nancing instruments
Approve funding program
Plan currency mix
Develop nancing plan
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Sovereign-Related Functions
Market Development
Market Regulation
Central Banking
Legislation
Managing Indirect and Contingent
Obligations
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