UNCLASSIFIED / NON CLASSIFIÉ Canadian Annual Derivatives Conference 2005 Bruce Rutherford Managing Director Capital Markets Risk Assessment Services (CMRAS)

UNCLASSIFIED / NON CLASSIFIÉ Agenda 1.Who are we and what do we do?  OSFI  Capital Markets Risk Assessment Services 2.Derivatives  Our views  Impact on our work 1.Who are we and what do we do?  OSFI  Capital Markets Risk Assessment Services Page 2 / 13

UNCLASSIFIED / NON CLASSIFIÉ 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

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

UNCLASSIFIED / NON CLASSIFIÉ OSFI activities 1.Regulation –Develop and interpret legislation and regulations –Issue guidelines –Approve requests 2.Supervision –Assess safety and soundness –Intervene in a timely manner Page 5 / 13

UNCLASSIFIED / NON CLASSIFIÉ 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

UNCLASSIFIED / NON CLASSIFIÉ Agenda 1.Who are we and what do we do? –OSFI –Capital Markets Risk Assessment Services 2.Derivatives Our view Impact on our work 2.Derivatives Our views Impact on our work Page 7 / 13

UNCLASSIFIED / NON CLASSIFIÉ 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

UNCLASSIFIED / NON CLASSIFIÉ Derivatives – Our review framework Pre-trading processes (Intent) Business planning Trading strategies Risk appetite 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) Page 9 / 13

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

UNCLASSIFIED / NON CLASSIFIÉ Derivatives – Our review framework Pre-trading processes (Intent) Business planning Trading strategies Risk appetite 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) Page 11 / 13  New product approval  Reputational risk review  Deal capture (exotic/structured products)  Model risk  Systems integration  P&L explanation  Process sign-offs

UNCLASSIFIED / NON CLASSIFIÉ Takeaways 1.From our viewpoint, derivatives are not inherently good nor bad; what matters is how they are used 2.Increasing complexity of derivatives impacts: Types of risk institutions are exposed to Our supervisory review framework 3.In the current dynamic regulatory environment, we are involved in: Development of international guidance Interpretation and application to Canadian banking industry Page 12 / 13

UNCLASSIFIED / NON CLASSIFIÉ Questions? Page 13 / 13