27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY
International Accounting Standards Frédéric Oudea, Group Chief Financial Officer Pierre-Henri Damotte, Head of Group Accounting Policies Hervé de Kerdrel, Head of Asset and Liability Management
27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY The IAS project Frédéric OUDEA
APPLICATION OF IAS IN EUROPE
Uncertainties over the adoption of IAS 39 Opposition from the banking sector has focused on one issue: macro-hedging Under IAS, sight deposits are not eligible for hedging, which is contrary to the current management practices of European banks The standards introduce unjustifiable volatility into shareholders’ equity
The IASB and prudential regulators are in disagreement over the Fair Value option Possibility of classifying all financial instruments (assets and liabilities) as trading instruments The prudential regulators have stressed that this option will reduce comparability and increase volatility The response to the consultation sparked reactions from the banking sector over the summer (Exposure Draft published in April 2004)
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APPLICATION OF IAS IN EUROPE
Probable options The European Commission deems that IAS 39 is unacceptable in its current form While waiting for a more satisfactory text, it supports the adoption of a temporary solution with the following provisions: Sight deposits can be included in macro-hedging mechanisms The Fair Value Option will not be applied to financial liabilities
The Accounting Regulatory Committee should vote on this proposal at the start of October 2004
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THE IAS PROJECT
What strategy to adopt in this climate of uncertainty? The Group launched its IAS project in July 2002 The project is supported on a day-to-day basis by the Group Finance Department, and supervised by the General Management The central project team coordinates separate projects for each business Some key issues are being coordinated with Basel II (Provisions, financial reporting)
As of the start of 2005, accounts will be published in accordance with the standards that have been validated by that date The Group has organised itself to manage uncertainties over standards that have not yet been validated, e.g. IAS 39
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THE IAS PROJECT
A significant project for the Group Implementation is complex and we have paid a lot of attention to staff training The project represents a significant investment over the period 2002-2004 It adds EUR 45m in external costs to operating expenses over 3 years and EUR 10m in fixed investments (including improvements to tools and procedures), i.e. total costs of EUR 55m These costs are based on the current standards and timetable, but may increase if further changes are made Each business line books the project costs under operating expenses
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FINANCIAL COMMUNICATION
Société Générale Group’s financial reporting calendar Reporting currently complies with AMF/CESR* recommendations Progressive communication on the switch to IFRS Qualitative and then quantitative information, depending on the reliability of the data
The transition to IAS/IFRS will be made in key stages September 27th 2004: SG Day, first stage in financial communication February 10th 2005: publication of accounts according to French standards March 9th 2005: specific communication on IAS 2004 accounts May 25th 2005: publication of the opening balance sheet for 2005 under IAS and publication of P&L under IAS/IFRS
* AMF=French Financial Markets Authority 27 / 09 / 2004
Société Générale Investor Day
CESR=Committee of European Securities Regulators
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27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY Overview of the standards and their impact on the Group Pierre Henri DAMOTTE
INTRODUCTION
IAS: a new vision FR FR standards standards
IAS IAS standards standards
Balance sheet valuation based on historical cost Primacy of legal form
Moving towards wider use of fair value of assets and liabilities Substance over form
Earnings reflect operations carried out over the period + principle of conservatism
Balance sheet takes priority Information driven by the measurement of performance Reporting of opportunity gains and losses
Adaptation to sector taking into account management intent
Absence of sector-based standards Strong reluctance to use intent for accounting classification
Patrimonial vision
Financial vision
Source: Ernst & Young 27 / 09 / 2004
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INTRODUCTION
IAS: practical application The application of IAS implies the adoption of certain accounting options by each group The standards comprise a number of options, mainly for first-time adoption (e.g.: option to revalue real estate in the opening balance sheet, retroactive adjustment of acquisitions) The standards are based on principles, but no guidelines are provided for their practical application (e.g.: definition of materiality thresholds, practical methods for testing the efficiency of hedging)
The Group has to validate the practical application of some standards with our statutory auditors and the regulators, often in collaboration with industry working groups
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INTRODUCTION
Changes in financial reporting Modification of account presentation and valuation methods General structure of financial statements remains unchanged: Classification and valuation of financial assets and liabilities have been modified Content of intermediary results has been adjusted
Financial statements include additional, non-accounting information Increase in information provided in statement of changes in shareholders’ equity Introduction of cash flow statement Notes to financial statements include additional quantitative and qualitative information (e.g.: employee benefits, fair value of financial instruments not carried at fair value in the balance sheet, etc.) Provision of additional information on business segments
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INTRODUCTION
List of the main standards affecting the Group’s activities STANDARDS STANDARDS ENDORSED ENDORSED BY BY EU EU IAS IAS 19 19 IAS IAS 16, 36, 16, 36, 38, 38, 40 40 IAS IAS 27 27
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STANDARDS NOT ENDORSED BY EU
Employee Employee benefits benefits Fixed Fixed assets assets
Securities Securities IAS IAS 32 32 & & 39 39
Financial Financial instruments instruments
Derivatives Derivatives & & hedging hedging Day Day One One P&L P&L Provisions Provisions
Consolidation Consolidation Fees Fees & & commissions commissions
IFRS IFRS 22
Share Share based based payments payments
IAS IAS 17 17
Leases Leases
IFRS IFRS 33
Business Business combinations combinations
IFRS IFRS 11
First -time adoption First-time adoption
IFRS IFRS 44
Insurance Insurance contracts contracts
IAS IAS 18 18
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STANDARDS ENDORSED IN EUROPE
Employee benefits (IAS 19) Consequences of the standard All employee commitments must be identified and valued (e.g.: health care, pension funds, etc.) Provisions for these commitments are mandatory (optional under French standards) The net allowance expense for these commitments takes into account the fair value of the plan assets
2 material options: First-time adoption (IFRS 1): actuarial gains or losses can be booked to opening shareholder's equity in one go or spread over time in P&L For IAS 19: in the case of post-employment benefits, actuarial gains and losses can be spread out over time or recognised immediately in P&L
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STANDARDS ENDORSED IN EUROPE
Employee benefits (IAS 19) Implications for Société Générale At December 31st 2003, provisions were booked on the liabilities side of the consolidated balance sheet for commitments (net of existing plan assets) relating to pensions, early retirement and long service awards. All employee benefits offered by Group entities were identified The actuarial methods used to calculate commitments were harmonised (notably with local standards) Options retained at this stage: • First-time adoption (IFRS 1): actuarial gains and losses not previously recognised will be booked in one go • For IAS 19: future actuarial gains and losses will be booked over time
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STANDARDS ENDORSED IN EUROPE
Fixed assets (IAS 16, 36, 38 and 40) Consequences of the standard for accounting treatment and tangible fixed assets Fair value can be used on an ongoing basis to value investment property Depreciation is applied on a component basis and takes into account estimated residual value If the value in use of a tangible asset is less than its net book value after depreciation, an impairment loss must be booked to P&L
Convergence of French rules and IAS as of 2005 (excluding use of Fair Value) First-time adoption (IFRS 1): companies can choose to revalue fixed assets individually at their market value (at January 1st 2004), and retain this as the initial value
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STANDARDS ENDORSED IN EUROPE
Fixed assets (IAS 16, 36, 38 and 40) Implications for Société Générale Option currently being considered for first-time adoption (IFRS 1): no systematic revaluation of fixed assets in the Opening Balance Sheet Application of the component method for property, based on external valuations
Financial impact Outstanding assets: the net book value of the Group’s operating premises was EUR 2bn at December 31st 2003, while the value of its investment property was not significant
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STANDARDS NOT ENDORSED IN EUROPE
Business combinations (IFRS 3) IFRS 3 should be adopted shortly by the European Commission and will replace IAS 22 Consequences of the standard Treatment of acquisitions: • The assets and liabilities of the acquired company are entered at fair value in the accounts of the acquiring company, and goodwill is calculated as the difference between total fair value and the price paid. • Provisions for restructuring subsequent to the acquisition are booked to income • The pooling of interest method is no longer authorised: only the purchase method is permitted
Withdrawal of the principle of goodwill amortisation, including for acquisitions that predate the application of the standard. Introduction of impairment test for goodwill • Testing is carried out on each cash-generating unit, and not on each acquired legal entity • Any impairment in value is booked to income and is irreversible
Option for first-time adoption (IFRS 1) Companies can choose whether or not to adopt the new methods for business combinations predating January 1st 2004
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STANDARDS NOT ENDORSED IN EUROPE
Business combinations (IFRS 3) Implications for Société Générale Option for first-time adoption (IFRS 1): business combinations prior to January 1st 2004 will not be restated according to the new standards
Financial impact Outstanding goodwill at December 31st 2003: EUR 2.1bn Discontinuation of goodwill amortisation (amortisation charge of EUR 217m in 2003 P&L) No major impairment risk (impact on income): an examination of our portfolio of acquisitions shows that this risk is low for the foreseeable future
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STANDARDS ENDORSED IN EUROPE
Other issues Consolidation (IAS 27 and SIC 12*) IAS places substance over form for the application of the consolidation criteria specified by SIC 12 (decision-making powers and management control, ability to receive the majority of benefits, exposure to the majority of risks) No major changes to be made in consolidation scope
Fees & commissions (IAS 18) Syndication fees are already spread over time under French standards (no impact from IAS) Some adjustments (spreading of commissions over time) will need to be made, notably in retail banking: commission on payment cards, loan application fees, sales commissions The impact on the opening balance sheet and NBI will be limited
* SIC = Standing Interpretations Committee 27 / 09 / 2004
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STANDARDS ENDORSED IN EUROPE
Other issues (cont.) Leases (IAS 17) The provisions of this standard are very similar to the accounting principles already applied by the Group, both for the classification of leases (finance lease/operating lease) and for their respective treatment
Provisions for risks and charges (excluding PEL/CEL mortgage savings schemes) Integration of the time factor: calculations include a discounting mechanism Impact for Group is very limited
Presentation of shareholders’ equity The general reserve for banking risks (EUR 312m at Dec. 31st 2003) is reincorporated into shareholders’ equity. This has no impact on regulatory capital ratios as it is already taken into account in Tier one capital Minority interests will be included in shareholders’ equity These These adjustments adjustments (excl. (excl. general general reserve reserve for for banking banking risks) risks) may may generate generate deferred deferred tax tax assets assets or or liabilities liabilities 27 / 09 / 2004
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PENDING ISSUES
Pending issues Accounting of mortgage savings schemes (PEL/CEL) Products specific to the French market: a suitable model is currently being defined for the valuation of contractual commitments Uncertainties remain over the standard to apply for the accounting of the corresponding liabilities
Share Based Payment (IFRS 2): mainly involves two compensation tools Stock options: used regularly (total outstanding: 4.5% of shares issued at end-August) Share issues reserved for employees • 5.2 million shares issued in 2004 • A working group is currently studying the issue under the supervision of the National Accounting Council (French accounting standards setter)
Recognition of benefits in P&L and no impact on the balance sheet
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27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY Overview of the standards and their impact on the Group: IAS 32 & 39 Pierre Henri DAMOTTE / Hervé de KERDREL
IAS 32 & 39
IAS 39: main issues Securities portfolios and treasury shares Hedging transactions (excl. ALM) ALM and macro-hedging Fair Value and the Day-One P&L issue Provisions for credit risks
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IAS 32 & 39
Reclassification of securities portfolios Under Under FR FR standards standards
Mark Mark to to market market in in P&L P&L
Amortised Amortised cost cost ++ LOCOM* LOCOM*
Trading Trading securities securities EUR EUR 92.6bn 92.6bn
Under Under IAS IAS standards standards
Financial Financial assets assets held held for for trading (HFT) trading (HFT)
Mark Mark to to market market in in P&L P&L
Available -forAvailable-forsale sale financial financial assets assets (AFS) (AFS)
Mark Mark to to market market under under shareholders’ shareholders’ equity equity Provision Provision for for long-term long-term depreciation depreciation
Held -toHeld-tomaturity maturity financial financial assets assets (HTM) (HTM)
Amortised Amortised cost cost Tainting rule Tainting rule Provision Provision for for credit risk credit risk
Short -term Short-term investment investment securities securities EUR EUR 27bn 27bn
Cost Cost of of acquisition acquisition ++ LOCOM* LOCOM*
Long -term equity Long-term equity investments investments
Amortised Amortised cost cost ++ provision provision for for credit risk credit risk
Long -term Long-term investment investment securities securities
EUR EUR 5.3bn 5.3bn
EUR EUR 25.1bn 25.1bn
* LOCOM = lower of cost or market 27 / 09 / 2004
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IAS 32 & 39
Hedging derivatives Under Under FR FR standards standards
Under Under IAS IAS standards standards
Fair Fair value value Hedge Hedge
Hedging Hedging derivative derivative and and hedged hedged instrument instrument at at Fair Fair Value Value in in P&L P&L
Micro -hedging Micro-hedging
Accrual Accrual of of interest interest or historical or historical value value
Cash Cash flow flow hedge hedge
Hedging derivative Hedging derivative: derivative:: at at Fair Fair Value Value in in shareholders’ equity shareholders’ equity (effective (effective part) part) Hedged Hedged instrument: instrument: amortised amortised cost cost
Macro Macro fair fair value hedge value hedge
Overall Overall revaluation revaluation of of hedged hedged assets/ /liabilities assets assets/liabilities at at Fair Fair Value Value in in P&L P&L
Trading Trading
Derivatives Derivatives at at Fair Fair Value Value in in P&L P&L
Macro -hedging Macro-hedging
Accrual Accrual of of interest interest or or historical historical value value
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27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY ALM and macro-hedging Hervé de KERDREL
ALM AND MACRO-HEDGING
ALM: a few reminders Principles for ALM Aimed at protecting our commercial margins from interest rate fluctuations (excl. trading activities) Hedging activities do not include any speculative positions
Commercial and own account transactions are hedged against interest rate and currency risks Micro-hedging: • for SG CIB’s commercial transactions • for retail banking operations over a certain threshold
Macro-hedging for other retail banking operations
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ALM AND MACRO-HEDGING
Macro-hedging: what’s at stake? Macro-hedging techniques apply to EUR 150bn in the balance sheet, out of a total EUR 600bn Some 15 entities use these techniques French Networks, Retail Banking outside France (KB, SKB), Specialised Financing, Group Capital Management
The total nominal amount of derivatives used in macro-hedging is limited Used to hedge gaps between fixed rate deposits and loans by maturity buckets Outstanding of some EUR 40bn
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ALM AND MACRO-HEDGING
Macro-hedging: An example – The French Networks Interest margins of the French Networks 6.0%
According to a gap analysis by maturity, the French Networks have a structural excess of fixed rate resources ªImmunisation of margins through the implementation of fixed rate swaps to neutralise gaps
5.5%
5.0%
10-year rate Standard deviation=0.5%
4.5%
4.0%
Interest margin Standard deviation=0.1%
3.5%
This “immunisation” smooths the impact of erratic movements in the yield curve
3.0%
3-month rate Standard deviation=0.9%
2.5%
2.0%
1.5% Q1 99 27 / 09 / 2004
Société Générale Investor Day
Q1 00
Q1 01
Q1 02
Q1 03
Q1 04
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ALM AND MACRO-HEDGING
IAS 39: a method of hedge accounting that doesn’t suit our economic approach IAS 39 does not allow the hedging of sight deposits They are taken at their contractual maturity (“payable on demand”)
Interest margin hedging is not recognised
ª The sole option allowed by IAS 39 to avoid earnings volatility is cash flow hedging and thus the recognition of the mark-to-market value of hedging swaps under shareholders’ equity This distortion in relation to the underlying hedged instrument (accrual of interest) generates increased equity volatility (cash-flow hedge)
ALM techniques, used to justify the economic effectiveness of hedges, are not eligible for IAS 39 Mark-to-market valuation of the non-effective portion in the P&L creates additional volatility
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ALM AND MACRO-HEDGING
What are the potential financial impacts? Artificial volatility in our shareholders’ equity… Impact of mark-to-market valuation of macro-hedging swaps is mainly positive in the current interest rate environment
… that would be neutralised by the prudential regulators Basel communiqué dated June 13th 2004
IAS 39 would make the comparability of financial statements more complicated IAS 39 accounting methods do not accurately reflect the value of interest margin hedges The artificial nature of the treatment of hedging derivatives would lead establishments to adopt different accounting options
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27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY Overview of the standards and their impact on the Group: IAS 32 & 39 Pierre Henri DAMOTTE
IAS 32 & 39
The Day-One P&L issue The issue relates to the recognition of the profit margin generated on the origination of a financial instrument The overall profit over the life of the instrument remains the same Profit recognition will depend on whether market parameters and prices are observable
Option: possibility of adjusting instruments as of October 25th 2002 (date of application of EITF* 02-03)
* EITF = Emerging Issues Task Force 27 / 09 / 2004
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IAS 32 & 39
The Day-One P&L issue Implications for Société Générale The Day-One P&L issue essentially concerns structured products comprising equity or interest rate derivatives and alternative investment products Work is currently underway on the documentation of observable market parameters used for valuation This issue concerns the entire banking industry (EITF 02-03)
Financial impacts Potential impact on the opening balance sheet for 2005 Advantage of having future earnings less correlated to annual production
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IAS 32 & 39
Provisions for credit risk Summary of the standard IAS 39 does not modify the assessment of risk nor the qualifying criteria for impairment The standard changes the method of calculation, by introducing discounting of cash flows The provision must be calculated on the basis of the NPV of all recoverable amounts, discounted at the original effective interest rate (EIR) The impaired receivable then generates interest income which is calculated by applying the EIR to its net book value
Convergence of French standards and IAS Harmonisation of the concept of discounting recoverable amounts Residual difference between the two methods of calculating and recognising subsequent interest and therefore in the amount of the provision
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IAS 32 & 39
Assumptions: Assumptions: loan loan of of 100 100 at at 10% 10% Doubtful Doubtful at at N N and and recovery recovery of of 40 40 at at end end of of N+2 N+2
Net Net present present value: value: 33 33 Discounting Discounting of of the the recoverable recoverable value value increases increases the the initial initial cost cost of of risk risk
Net Net present present value: value: 36 36
P&L P&L N N Cost Cost of of risk risk Pre-tax Pre-tax profit profit
Comparison of calculation methods FR FR
IAS IAS
Divergence Divergence
-- 60 60 -- 60 60
-- 67 67 -- 67 67
-- 77
-- 77
P&L P&L N+1 N+1
Booking Booking as as net net interest interest income income of of the decrease in NPV compared to the decrease in NPV compared to previous previous year year
Net Net interest interest income income Cost Cost of of risk risk Pre-tax Pre-tax profit profit
----
33 -33
33 --
Recovery: Recovery: 40 40
P&L P&L N+2 N+2 Net Net interest interest income income Cost Cost of of risk risk Pre-tax Pre-tax profit profit
-00 --
44 00 44
44 --
--- 60 60 -- 60 60
77 -- 67 67 -- 60 60
77 -- 77
Identical Identical P&L P&L contribution contribution with with both both standards standards 27 / 09 / 2004
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44
Total Total P&L P&L Net Net interest interest income income Cost Cost of of risk risk Pre-tax Pre-tax profit profit
00 36
IAS 32 & 39
Provisions for credit risk Specific provisions (identified risk on an individually assessed receivable) Implementation of procedures for assessing timing of recoveries: • through individual analysis of loans • through statistical modelling for groups of homogenous receivables
Provisions for groups of homogenous receivables, not individually impaired Concept of incurred loss but not individually assessed IASB allows provisions on portfolios of homogenous loans not individually impaired if there is objective evidence of impairment, but prohibits expected loss provisioning
Implications for Société Générale and financial impact Specific provisions deducted from assets: EUR 7.2bn at Dec. 31st 2003 Provisions for sector and country risks under review (EUR 1bn at Dec. 31st 2003)
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IAS 32 & 39
Other issues Insurance (IFRS 4) The interim standard for insurance contracts allows local texts to be used until an additional standard is published (by 2006/2007) As a result, few changes are expected in 2005 for insurance products Insurance liabilities will be treated in accordance with French standards and valued at amortised cost, while financial assets will be carried at fair value (IAS 39) • Asset and liability mismatch • Use of the concept of Deferred Profit Sharing for life insurance contracts in EUR to limit this mismatch
Effect on our insurance activities: • An industry working group is currently studying the accounting of Deferred Profit Sharing
Treasury shares (IAS 32 and SIC* 16) Treasury shares and equity-settled derivatives on treasury shares held by the issuing company must be deducted from shareholders’ equity. In principle, this will have no impact on regulatory capital Adjustment of trading gains on this specific underlying instrument * SIC = Standing Interpretations Committee 27 / 09 / 2004
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27 / 09 / 2004
SOCIETE GENERALE INVESTOR DAY Conclusion
CONCLUSION
Summary of the impacts IAS will not alter the way the Group does business, nor will it lead to any changes in Group strategy Opening balance sheet at January 1st 2004: Main impact: IAS 19 on employee benefits. The impact will be offset in shareholders’ equity by the write-back of the general reserve for banking risks (EUR 312m at Dec. 31st 2003) Overall estimated reduction of Tier one between 10 and 20 bp
2004 earnings: Limited impact as IFRS 2 (stock options and share issues reserved for employees) will be offset by the elimination of goodwill amortisation
The precise impact of IAS 39 on the accounts still needs to be determined and will depend on the outcome of the ongoing discussions
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27 / 09 / 2004
Appendix ALM and macro-hedging Hervé de KERDREL
ALM AND MACRO-HEDGING
ALM: a clear and strict organisation Hedging of interest rate risk is decentralised The finance department of each entity is responsible for its own ALM The Group Finance Department is in charge of risk management and the consolidation of residual risks
Hedging transactions are carried out through SG CIB’s market activities (treasury and fixed income products) Hedging transactions transfer interest rate risks to the market
The management of interest rate risk is based on an analysis of exposure to fixed interest rate risk by maturity bucket – using the gap method The analysis is conducted using the current balance sheet, and not the future balance sheet Contractual transactions are scheduled according to their maturity date Non-contractual transactions (sight deposits, regulated savings, early repayments) are integrated according to behavioural models
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ALM AND MACRO-HEDGING
Derivatives: usage is restricted to simple transactions The first priority is to hedge the balance sheet using commercial transactions (natural hedging) Derivatives hedging is used in the following cases: Micro-hedging for basic transactions Macro-hedging for retail banking transactions
In all cases, hedging complies with strict principles Protection of margins from commercial transactions No speculative positions
Use of simple derivatives (swaps, forward swaps, plain vanilla options) for ALM Entities with a surplus of fixed rate deposits (or low rate) Î swaps receiving in fixed rate Entities with a surplus of fixed rate loans Î swaps paying in fixed rate Behavioural options Î risk equivalent with neutral delta (swaps) Explicit financial options (capped mortgage loans) Î optional derivatives (caps/floors) 27 / 09 / 2004
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