Société Générale / Risk report 2021 - Pillar 3 2020

9 MARKET RISK MARKET RISK MAIN MEASURES PILLAR 3 - 2021 | SOCIETE GENERALE GROUP | 174 MARKET RISKMAINMEASURES 9.3 Stress test assessment Societe Generale monitors its exposure using stress test simulations to take into account exceptional market disruptions. A stress test estimates the loss resulting from an extreme change in market parameters over a period corresponding to the time required to unwind or hedge the positions affected. Two major metrics are defined and used: the Global Stress Test on market activities, which estimates the p losses linked to market risks, market/counterparty cross-risk, and dislocation and carry risk on exotic activities, that could arise simultaneously in the event of a severe but plausible systemic crisis. This stress test is modeled on five scenarios; the Market Stress Test, which focuses solely on market risks, p applying the same scenarios as the Global Stress Test and additional scenarios corresponding to different market conditions. The various scenarios for those stress tests are reviewed by the Risk Division on a regular basis. These reviews are presented during dedicated biannual Committees, chaired by the Market Risk Department and attended by economists and representatives of Societe Generale’s trading activities. These Committees cover the following topics: changes in scenarios (introduction, removal, shock review), appropriate coverage of the risk factors by the scenarios, review of the approximations made in terms of calculation, correct documentation of the whole process. The delegation level needed to validate the changes in stress test scenarios depends on the impact of the change in question. These stress tests are applied throughout all the Bank’s market activities. Stress test limits are established for Societe Generale’s activity as a whole (and then for the Group’s various business lines for the Market Stress Test). Together with the VaR model, these stress test risk assessments are one of the main pillars of the risk management framework. GLOBAL STRESS TEST ON MARKET ACTIVITIES The Global Stress Test on market activities is the main risk indicator used on this scope. It covers all the risks on market activities that would occur simultaneously in case of a severe, but plausible, market crisis. The impact is measured over a short period of time with an expected occurrence of once per decade. The Global Stress Test uses five market scenarios and has three components, each of which are considered in each of the five scenarios in order to ensure consistency within the same scenario: market risk; p dislocation and carry risks on exotic activities related to p concentration effects and crowded trades; market/counterparty cross-risks arising in transactions with weak p counterparties (hedge funds and proprietary trading groups). The Global Stress Test corresponds to the least favourable results arising from the five scenarios and their respective components. Market risk component It corresponds to: the results of the Market Stress Test (1) restricted to scenarios that p could cause dislocation effects on market positions and default by weak counterparties. These scenarios all simulate a sharp fall in the equity markets and a widening in credit spreads which could trigger dislocation effects. Following the last review of the scenarios at the end of 2020, it was decided to use for the calculation of the stress test three theoretical scenarios (generalised ( i.e. financial crisis scenario), eurozone crisis, general decline in risk assets) and two historical scenarios focusing respectively on the period of early October 2008 and early March 2020; the impact of the stress test scenario on CVA (Credit Value p Adjustment) and FVA (Funding Value Adjustment) reserves, as their variations affect trading results. Dislocation and carry risk component Additional market risks to those assessed in the Market Stress Test can occur in market situation in which one or more participants – generally structured products sellers – have concentrated or crowded trades. Dynamic risk hedging strategies can cause larger market dislocations than those calibrated in the Market Stress Test, and these dislocations can extend beyond the shock timeline used due to an imbalance between supply and demand. Equity, credit, fixed income, currency and commodity trading activities are regularly reviewed to identify these areas of risk and to define a scenario that takes into account the specific features of each activity and position. Each scenario associated with an identified area of risk is added to the market risk component if – and only if – it is compatible with the market scenario in question. Market/counterparty cross-risk component on weak counterparties Some counterparties may be significantly affected by a major crisis on the financial markets and their probability of default may increase. The third component of the Global Stress Test therefore aims to take into account this increased risk on certain types of weak counterparties (hedge funds and proprietary trading groups). Two measurements are used: the collateralised financing stress test: this stress test focuses on p collateralised financing activities and more specifically on weak counterparties. It applies a dislocation shock to several asset classes with the assumption of extremely tight liquidity conditions. Collateral and counterparty default rates are stressed concomitantly, taking into account any consanguinity with the collateral posted; the adverse stress test on hedge funds and proprietary trading p groups (PTG): this stress test applies two stress scenarios to all market transactions qualifying for replacement risk with this type of counterparties. A stressed probability of default – based on the counterparty’s ratings – is taken into account. Measurement of the impact in the Net Banking Product in case of shocks on all risk factors (refer to below description). (1)