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Opalesque Industry Update - SunGard’s APT risk system has modelled different Euro breakup scenarios, using a global factor model incorporating macro-economic factors to estimate cross-asset class effects. The results cover the impact of five main Euro breakup scenarios across FX, interest rates, equities, oil and credit spreads.

In creating the scenarios, APT drew on a variety of leading recent economics research and focused on the mechanisms by which shocks are transmitted between different asset classes, reviewing the two most recent sovereign debt shocks to markets, in March 2010 and August 2011. These historical scenarios helped APT calibrate the relative scale of expected volatility shocks for each explanatory factor. Scenarios are described by a set of shocks to both level and volatility of any set of macro variables (explanatory factors) which can be represented within the factor model.

This approach helped APT generate five different potential scenarios of concern:
1. One country leaves - Greece
2. Two countries leave - Greece & Portugal
3. Five countries leave - Greece, Portugal, Ireland, Italy, Spain
4. One country leaves – Germany
5. Total collapse of Euro zone

Full shock scenario values chart attached below, highlights include:

• The departure of Greece and Portugal would lead to a 15% rise in the Euro against the dollar, a 20% fall in Eurozone yields (ie the swap curve), a 15% fall in Eurozone equities and a 20% increase in credit spreads (ITRAXX Europe).
• The PIIGS five country scenario would see a 25% rise in the Euro against the dollar, a 40% drop in the Euro yield curve, a 20% drop in Euro equities and a 15% drop in US equities. In addition EU banking stocks would fall by 25% and ITRAXX Financials credit spreads would increase by 100%, which would imply downgrades and losses of up to 20% in high-grade corporate debt. This scenario also predicts losses of up to 15% for global equities with near-doubling of volatility and the VIX over 50.
• A total collapse scenario would see European equities down 40%, US and global equities down 30%, Euro yields down 75% and ITRAXX Europe and ITRAXX Financials credit spreads up 150% and 200% respectively.
• Oil would fall across the scenarios, ranging from 5% from a Greece departure through to a 50% decline from a complete breakup.
• Sterling would strengthen against the Euro by between 5-25% across the scenarios.
• Volatility would increase across all assets across the scenarios (with even a Greece exit resulting in volatility increasing by between 25% and 50% across equities).

The results seek to model the impact of each scenario over three months, looking eight weeks before and six weeks after the shock to form a balanced picture.

SunGard APT’s Head of Research Dr Laurence Wormald comments: “We want to help professional investors think logically about the potential impact of different Euro breakup scenarios on their portfolios. We’re not predicting exact timing, though clearly the next six months have a variety of known critical dates, as well as possible unknown flashpoints.

“It’s important to realise that this is not a black swan, it’s a widely discussed possible event, and while unprecedented it can’t be classed as very improbable, nor would it be rare. Since 1945, 87 countries have left currency unions.

“We’re not analysing the probability of breakup, but the likely consequences it would bring, helping investors make contingency plans. While comprehensive hedging of such scenarios is often unrealistic, investors can model scenarios and consider potential hedges on risks such as credit risk, FX risk, oil and equity risk. Of course, the resulting scenario shocks are no more than very rough estimates, but it is understanding the order of magnitude and inter-relationships that is critical for investors. For example a severe recession in the European countries would have real-economy effects, leading to enormous pressure on global equities markets, including exporters such as China and the commodities producing nations.”

“It is still seems probable that no action to change the current composition of the Eurozone is likely at the present, and the scale of the next market/political crisis would have to be large enough to be a real threat to the creditworthiness of both Germany and France before such action would be probable. But now is the time for good risk management on multi-asset class portfolios.”

SHOCK SCENARIO VALUES CHART HERE
See note below table for more explanation of the market factors included in the scenarios

Definition of Scenario Factors APT scenarios are based upon shocks to the following market risk factors
• FX factors: EUR, GBP, USD (representing changes to exchange rates between those currencies)
• Swap Curve factors: EUR, GBP, USD Shift factors (representing changes to short- and long-term interest rates in those currencies)
• Equity Market factors: US, EU, GB, Asia (representing changes to broad market indices in those equities markets – “Leaver” refers to the market of any country leaving in that scenario)
• CDS Spread factors: European ITRAXX spreads (representing changes to the price of insuring credit against default for those sections of the corporate bond markets, especially Banks)

SunGard’s APT www.sungard.com/apt/learnmore

SunGard www.sungard.com

BG