## Country risk 

Country risk is defined as losses arising from events in a country that include an act of government, war, terrorism, civil strife or economic crisis. 

The Country Risk Policy guides the management of Macquarie’s country risk. Countries are grouped into categories based on the country’s risk profile. Before any exposure is taken in a country that is considered to be high- risk, a review of the economic, political and operating environment is undertaken to determine the level of exposure that is considered to be acceptable. Where appropriate, measures to mitigate country risk are put in place. 

## Market risk 

Market risk is the exposure to adverse changes in the value of Macquarie’s trading portfolios as a result of changes in market prices or volatility. Macquarie is exposed to the following risks in each of the major markets in which it trades: 

GLYPH<150> foreign exchange and bullion  – changes in spot and forward exchange rates and bullion prices and the volatility of exchange rates and bullion prices 

GLYPH<150> interest rates and debt securities  – changes in the level, shape and volatility of yield curves, the basis between different debt securities and derivatives and credit margins 

GLYPH<150> equities  – changes in the price and volatility of individual equities, equity baskets and equity indices, including the risks arising from equity underwriting activity 

GLYPH<150> commodities and energy  – changes in the price and volatility of base metals, agricultural commodities and energy products. 

Macquarie is also exposed to the correlation of market prices and rates within and across markets. 

Macquarie has long favoured transparent scenario analysis over complex statistical modelling as the cornerstone of risk measurement. 

## Trading market risk 

All trading activities contain calculated elements of risk taking. Macquarie is prepared to accept such risks provided they are within agreed limits, independently and correctly identified, calculated and monitored by RMG, and reported to senior management on a regular basis. 

RMG monitors positions within Macquarie according to a limit structure that sets limits for all exposures in all markets. Limits are applied at a granular level to individual trading desks, through increasing levels of aggregation to divisions and Operating Groups, and ultimately, Macquarie. This approach removes the need for future correlations or scenarios to be precisely predicted as all risks are stressed to the extreme and accounted for within the risk profile agreed for each business and Macquarie in aggregate. 

Limits are approved by senior management with appropriate authority for the size and nature of the risk, and Macquarie adheres to a strict ‘no limit, no dealing’ policy. If a product or position has not been authorised and given a limit structure by RMG, then it cannot be traded. Material breaches of the approved limit structure are communicated monthly to the Macquarie and Macquarie Bank Boards. RMG sets three complementary limit structures: 

GLYPH<150> contingent loss limits  – worst case scenarios that shock prices and volatilities by more than has occurred historically. Multiple scenarios are set for each market to capture the non-linearity and complexity of exposures arising from derivatives 

GLYPH<150> position limits  – volume, maturity and open position limits are set on a large number of market instruments and securities in order to constrain concentration risk and to avoid the accumulation of risky, illiquid positions 

GLYPH<150> Value-at-Risk (VaR) limits  – statistical measure that determines the potential loss in trading value at both a business and aggregate level. 

The risk of loss from incorrect or inappropriate pricing and hedging models is mitigated by the requirement for all new pricing models to be independently tested by the specialist Quantitative Applications Division within RMG. 

## Aggregate measures of market risk 

Aggregate market risk is constrained by two risk measures, VaR and the Macro-Economic-Linkages (MEL) stress scenarios. The VaR model predicts the maximum likely loss in Macquarie’s trading portfolio due to adverse movements in global markets over holding periods of one and 10 days. The MEL scenario utilises the contingent loss approach to capture simultaneous, worst case movements across all major markets. Whereas MEL focuses on extreme price movements, VaR focuses on unexceptional changes in price so that it does not account for losses that could occur beyond the 99 per cent level of confidence. For this reason, stress testing remains the predominant focus of RMG as it is considered to be the most effective mechanism to reduce Macquarie's exposure to unexpected market events. 

## Macro-Economic-Linkages 

MEL calculates Macquarie’s total market risk exposure to global market stress test scenarios extrapolated from historical crisis events and global market correlations. Each stress test scenario includes a primary shock to either equity or energy markets as well as cross-market effects in corporate margins, metals, foreign exchange, interest rates and commodities. MEL is Macquarie’s preferred internal measure of aggregate market risk because of the severity of the shocks applied and the ability for scenarios to develop with changing market dynamics. MEL is monitored and reported to senior management daily and to the Board regularly. It is reviewed by RMG regularly to ensure the measure remains appropriate for changing market conditions and the risks to which Macquarie is exposed. 

The ‘Market Contagion’ scenario, typically the most conservative of the MEL stress test scenarios, accounts for all the significant markets to which Macquarie is exposed. The assumptions in this scenario are considerably more severe than the conditions that prevailed throughout the Global Financial Crisis. The 'Market Contagion' scenario measures the impact of an instantaneous equity market crash of 15 to 30 per cent as well as additional shocks to foreign exchange, metals, interest rate, energy, agricultural commodity and credit markets. Macquarie’s exposure to the ‘Market Contagion’ stress test scenario increased slightly compared to last year as trading businesses managed exposures whilst looking to take advantage of recovering markets. The average exposure to the MEL stress test scenario represents less than five per cent of total equity. 

