On a shelf above Jonathan M. Boylan's desk sits a decidedly odd adornment: a miniature coffin filled with losing lottery tickets.
"This is a reminder to always end up in the money and not to expire worthless," says KeyCorp's chief of market risk. "You don't want to lose all of your value."
That's more than idle talk for Mr. Boylan. He is responsible for making sure that the company's 40 traders don't gamble away its capital.
Traders at the Cleveland-based bank spend their days buying and selling swaps, futures, options, and bonds, which have varying maturities and react differently to changes in interest rates.
Figuring out how much each instrument is worth is difficult; determining how they affect the bank's overall risk profile is nearly impossible.
And the job isn't getting any easier. The notional value of derivatives contracts held by banks has tripled in five years, to $20 trillion. And the value of securities and other instruments in bank trading accounts was $241 billion at the end of 1996, up 10% from 1995.
That's why regulators are pushing risk management and why banks are hiring executives like Mr. Boylan to manage market risk exposures. Using sophisticated modeling techniques, Mr. Boylan, senior vice president of financial risk review, keeps Key's top managers and the board of directors informed about the institution's $7 billion portfolio.
"The main point of my job is to keep on top of what is happening," Mr. Boylan said. "It is a management role. I don't actually spar with the traders. I make sure the systems we have in place work."
To monitor these risks, Mr. Boylan relies on two computer models, which produce reports detailing the Cleveland banking company's exposure to sudden swings in interest rates and foreign currency exchange rates.
KeyCorp's culture discourages big risk-taking, preferring steady profits to a roller coaster of large profits and losses, Mr. Boylan said. For example, KeyCorp estimates that even an unexpected change in interest rates would only cause a $56,000 loss to a derivatives portfolio with a $2 billion notional value.
"We take much less risk than a money-center bank," he said.
Arriving at his fifth floor office around 7:30 a.m., Mr. Boylan's first task is to analyze what Key calls the "risk-units report," the older and simpler of the two studies his department creates.
The 10-page report lists every security the bank owns. It includes the purchase price, market price, gains, losses, and risk units. Risk units are a quick-and-dirty way to show what would happen to each security if short- term rates for Treasury securities change just 1 basis point. Each trader must keep his portfolio within a pre-set number of risk units.
"They are a good, rough approximation of risk," Mr. Boylan said. "Traders understand them and can use them to stay within their boundaries.
"I look for big changes," he said. "If they are riding a position that is accumulating losses, we want to be able to question the traders on it."
The report also flags exotic securities, to ensure traders aren't doing "anything strange or unusual," he said.
Mr. Boylan's second report shows the results of the bank's value-at-risk model. This relatively new technique, which is being adopted by most large banks, has several advantages over the risk units report.
First, the model actually recalculates the value of each instrument based on expected changes in rates or prices. The risk units report, by contrast, uses the effect of rate hikes on short-term Treasury bonds as a proxy for how the hikes will change the values of individual securities.
Also, VAR models account for off-setting risks, producing a more accurate picture of the bank's risk profile. Finally, the model is more flexible. That is, it can be programmed to calculate the impact of hundreds of different combinations of interest rates and price changes while the risk unit report looks at a single, very small change in Treasury bond prices.
These models get a strong endorsement from regulators.
Christopher Moore, the director of banking supervision and regulation at the Federal Reserve Bank of Cleveland, said the models-in addition to helping banks administer their portfolios-allow risk managers to identify rogue traders when they first start racking up massive losses.
"These models are critical," he said. "We saw what can happen without these controls in the Barings case." The U.K.-based Barings Bank was crushed by trading in a relatively simple form of futures contracts.
Key's VAR model currently tracks foreign exchange, derivatives, and securities trading for the trust department. The bank is in the process of adding taxable and tax-exempt bonds that are traded in its section 20 subsidiary.
The model allows Key to identify major risks, such as rising interest rates or shrinking spreads between the U.S. and Eurodollars.
As Mr. Boylan tackles this job, he brings the watchful eyes of a regulator. He joined the Office of the Comptroller of the Currency in 1977 as a trust examiner and moved around the agency for the next 18 years. Before leaving in 1995, he worked on the agency's policy statement on derivatives.
He has no regrets about the career switch. "It is much more gratifying to work on a project and then see results," he said. "It was amazing how little impact regulators had on a day-to-day basis."
One of Mr. Boylan's tasks is to decide which risks warrant the most attention.
"There are so many risk factors that if you showed every one you'd get information overload," he said.
He said he prefers to look at 200 basis-point interest rate shocks, which he said provide one of the most accurate estimates of a portfolio's sensitivity to rate changes.
Finally, Mr. Boylan must decide what assumptions the model should use when it calculates the risk a security poses. For example, Key assumes that it will hold a security for 24 hours, when in reality traders buy and sell all day.
Despite its imperfections, Mr. Boylan said VAR models produce the most accurate picture possible of the riskiness of an institution's portfolio.
KeyCorp had little choice but to adopt a VAR model, because it plans to ask the Fed shortly for permission to underwrite commercial securities. The Fed typically has required these models before approving expanded section 20 powers.
Shiv Krishman, president of Key Capital Markets Corp., the holding company's section 20 unit, said models also aid traders, who need to know how risky their portfolios are before deciding which securities to purchase or sell.
"We are putting capital at risk," he said. "We need an effective way to measure risk."
One of Mr. Boylan's hardest tasks is keeping in regular contact with traders. "As an independent risk management function, there is automatically a distance between me and the risk taker," he said.
To bridge this gap, Mr. Boylan said he tries to develop relationships in which traders feel comfortable consulting him before buying a complex, new instrument. He tries to visit the trading floors to build personal relationships and often conveys traders' concerns about risk limits to senior management.
"We need their cooperation and respect," he said.
To ensure independence, Mr. Boylan's six-person group is housed in the holding company's management subsidiary, while the traders work either for the section 20 affiliate or the lead bank's trust department.
Mr. Boylan also knows that there is no one looking over his shoulder-he is the last line of defense against rogue traders that want to gamble away the bank's capital. Perhaps that explains why his screen saver says "Sed quis custodiet ipso custodies," a Latin quote from Roman poet Juvenal that translates into, "But who will guard the guards themselves?"