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Opinion: Identifying Portfolio Exposures with Cross Reference Data

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By Jackson Griffith, Director of Enterprise Solutions, S&P Valuation and Risk Strategies, McGraw-Hill Financial

When a negative market event occurs, risk managers need to quickly determine their exposure to it and the impact it may have on their portfolio. Exposure can come in many forms and may not be obvious at first glance. For example, it can be to an entity through its own issuance of equity or debt, securities issued by the parent, subsidiaries, affiliates and obligors, or being a counterparty in a business transaction.

In addition, exposure can occur across industries, sectors and countries, as a result of rating actions or through financial covenant changes, such as when borrowing limits get adjusted based on the net asset value of a portfolio.

The use of cross reference data can help firms effectively assess their overall portfolio exposure and uncover potential risks in these sorts of situations. We can illustrate the point by looking at two significant events from 2010: the sovereign debt crisis in Greece and the Deepwater Horizon oil spill involving British Petroleum (BP) PLC.

Bordering on fiscal collapse, Greece had to seek financial assistance from other members of the EU, the International Monetary Fund (IMF) and the European Central Bank (ECB) to meet its debt obligations and prevent a potentially catastrophic default. The unemployment rate in Greece reached more than 12% and on 27 April 2010, S&P downgraded its sovereign debt to BB+ with a negative outlook. S&P analysts also estimate that the debt to GDP ratio may hit 131% in 2011.

There was also the risk of contagion to other similarly placed countries including Portugal, Ireland, Italy and Spain. With that in mind, one can illustrate how cross reference data can be used to help uncover exposure to related entities. At Standard & Poor’s, we conducted a top down examination of how many banks domiciled in Greece, Spain and Portugal were connected to sovereign entities through direct ownership of their securities.

Using the ISO codes for Greece (GR), Spain (ES) and Portugal (PT), and bank sector codes for such entities as federal reserve banks, central reserve depositories, bank holding companies, commercial banks and others, we created a report that identified 108 different banks within these three countries with this exposure. Within this group there were 705 outstanding and active securities as of Q3 2010.

Further insight on exposure to a particular company comes from drilling down to the securities the company issues, its ownership structure and the securities that related entities issue. To take one case in point, we also took a deeper view on Banco Santander SA, one of the banks uncovered in our original top down report.

By using global entity identifier mapping, we were able to see related entities and their issues that one may not commonly expect to be associated with Banco Santander. In this particular example, 124 related issuers based on the first six digits of the nine digit CUSIP/CINS identifier are assigned to eight major subsidiaries. In total, there were 277 unique issuer identifiers listed under Banco Santander, which pertained to more than 4,000 outstanding securities for that one entity.

In addition to concerns over sovereign debt, there are other events that can cause specific companies to become front page news. For example, BP PLC hit the headlines after the explosion of the Deepwater Horizon rig in April 2010, triggering the massive oil spill in the Gulf of Mexico.

Within a few weeks of the explosion, BP’s share price had fallen by roughly 17% and on 7 May, Standard & Poor’s assigned a negative outlook as concerns over the eventual costs of clean up and damage repair mounted. Over the course of the next month, BP’s share price had fallen by more than 50% from its 20 April close; S&P had downgraded BP’s long-term credit rating twice, from AA to A; and credit default spreads, as indicated by the MDS line, underscored deep market concerns.

Investors were immediately asking if any of the securities in their portfolios had exposure to BP based on ownership, based on obligation or if there were any entities that BP would be on the hook for, from a debt servicing perspective.

In our exposure analysis, we took both a top down and bottom up approach to dig deeper into the BP situation to identify what this means for a particular portfolio.

With the top down approach, you can start with the BP PLC global identifier and call up the universe of fixed income securities associated with BP. Next, you can retrieve the related details, such as identifiers, the terms and conditions and associated obligors. Our initial analysis revealed 2,795 instruments outstanding for BP PLC.

For the bottom up analysis, we used our Associated Obligor data service to identify all bonds and debentures that are related to BP by the firm’s obligation to service the debt. Without this insight, these securities would be completely unrelated in any other form and would not appear in any issuance report, public filings pertaining to BP or ownership structure report.

As the Greece and BP examples show, exposure can come in many forms and, if not identified quickly using a thorough and reliable range of reference data services, can have a severe negative impact on investment strategies. Effective cross referencing is essential to timely and accurate risk management.

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