Stock slump dents income, hikes VAR by 22% at UBS

Income from equity derivatives trading plummeted $47 million quarter-on-quarter

Whipsawing stock markets caused risk indicators to surge at UBS and frightened clients out of trading, leading to a 10% dive in the bank’s equities revenues in the fourth quarter of 2018.

Income from equity derivatives trading plummeted $47 million (23%) and from cash equities trading $16 million (5%) in the last three months of the year. Overall, the equities divisions’ revenues slipped $92 million to $792 million.

The burst in volatility also led to an increase in the bank’s own average value-at-risk levels, which rose 22% to $11 million from $9 million in the third quarter. UBS also reported a VAR backtesting exception in the fourth quarter, meaning trading losses exceeded its estimates one day in the three months to end-December. There were two VAR exceptions in total in 2018.

Regulatory VAR and stressed VAR increased in concert, contributing to an $8.3 billion (72%) jump in market risk-weighted assets to $20 billion at end-2018.

Part of the hike was also prompted by a series of updates to UBS’s risks-not-in-VAR framework, which added $1.4 billion to market RWAs. This increase was offset slightly by a model update, which garnered an RWA saving of $500 million.

Combined credit, market and operational RWAs rose $6.7 billion (2.6%) to $263.7 billion in the fourth quarter. Lower operational RWAs partially counteracted higher market and credit RWAs.

What is it?

UBS’s own management VAR model is calibrated to a 95% confidence level over a one-day time horizon, meaning a backtesting exception – where actual losses exceed those projected –  would be expected one in every 20 trading days. For regulatory VAR, a 10-day holding period and 99% confidence level are applied.

Swiss banks are obliged to calculate their total market RWAs by taking the maximum of regulatory period-end VAR and the average VAR for the 60 days preceding the period-end and applying a Finma-set multiplier. This multiplier dials up and down, depending on the number of VAR backtesting exceptions a firm experienced in a preceding 250 business-day window. This figure is then multiplied by a risk weight.  

A firm with four or fewer backtesting exceptions is assigned a flat 3x multiplier. This increases incrementally to a 4x multiplier as exceptions rack up.

Why it matters

Elevated volatility and higher VAR usually go hand in hand as a bank’s risk of big losses increases, so no surprises there. However, excitable markets often prompt greater trading activity, which can lead to a boost in revenues, helping to counteract the increase in market risk capital that banks have to hold during these periods.

This didn’t happen at UBS in the fourth quarter. The bank’s clients stepped away from markets, starving it of trading revenue.

A similar dynamic played out at JP Morgan during the fourth quarter, and we expect to see more of the same in the coming days, as European bank earning season begins.

Market RWA volatility is especially pronounced at UBS, though, with huge swings reported between quarters. The bank’s risk managers might want to delve into why.

Get in touch

What do you make of UBS’s latest results? You can drop us a line at alessandro.aimone@risk.net, send a tweet to @aimoneale, or get in touch on LinkedIn.

Keep up with the Quantum team by checking @RiskQuantum for the latest updates.

Tell me more

JP Morgan VAR surges 46% in Q4

VAR cut helps shrink UBS market RWAs

Swiss banks’ market risk drops by $12 billion

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