Star ESG

Real-World Economic Scenario Generation

2 towerswatson.com
Star ESG
Real-World Economic Scenario Generation
Overview of Star ESG
Star ESG is a leading software toolkit providing
fnancial modelling and risk analytics to the
insurance, pension and banking communities.
Star ESG is used by our clients to manage
and report on risk exposures in excess of
US$3 trillion, and forms a key component of
the advice driving our fduciary mandates.
Star ESG is a fully coherent and integrated
stochastic monte-carlo generator covering a
wide array of economic and fnancial risk metrics
including interest rates, credit spreads, equities,
property, FX and many alternative series. These
metrics are then used to determine the full
distribution of returns at one-year and multi-year
projections for a wide range of assets (and at both
aggregate and/or individual security level detail).
Over 60
clients
globally
North
America
18
Europe
31
Asia
Pacifc
3
As you navigate the regulatory seas, Star ESG
provides a fully transparent framework ensuring
easy adoption, validation and ownership of the
calibration, analytics and sensitivities that drive
your business. Every line of code is visible, audited
and documented easing the regulatory burden.
Star ESG is supported by a team of 50+
consultants who have academic and commercial
experience of working this feld. Specialisms range
from economics and econometrics, capital and
risk, actuarial advisory, asset pricing, trading,
risk management and systems engineering.
Star ESG 3
Figure 01. Igloo software
Example model
Economic Scenario Generation
At a high level, Star ESG is a suite of tools
supporting clients with the assessment of economic
and fnancial risk. Technically, these tools provide a
coherent and integrated, arbitrage-free, real-world
ESG. They use best of breed technical models to
simulate the full range of possible outcomes for
the economic and fnancial series driving market
risk. Star ESG focuses on economic realism, both
in respect of the direct economic items modelled,
and how these measures subsequently impact
movements in asset series returns. Furthermore,
Star ESG incorporates a full suite of asset and
portfolio analytics to ensure that series move
coherently and coherence is also captured by an
econometric cascade and tail copula framework.
A tail copula helps ensure we capture the changes
in correlation as market movements become
more extreme.
The Star ESG calibration is focused on the full
distribution of results, including the tails, average
levels and volatilities and not only at one year
but also at multiple year horizons. This ability to
model both short-term and long-term risks via the
same modelling framework supports the coherent
assessment of frm-wide risk as advocated by
modern enterprise wide risk management (ERM).
Consequently, Star ESG is appropriate for risk
management, determination of capital, business
planning, hedging strategies, portfolio construction
and holistic ERM.
Operational features
The ESG is calibrated quarterly and can be used
to project monthly, quarterly or annual scenarios
(or indeed any other custom time step). Moreover,
users can update the starting values as frequently
as daily always ensuring that full audit trails
remain for anything modifed.
To date the ESG generates series for the
following currencies:
The Star ESG library can be deployed to clients
as a toolkit library based on the Towers Watsons
Igloo software platform. This is a high speed
parallelised, scalable, stochastic simulation
platform capable of running over one million
scenarios. Alternatively, clients can purchase
pre-generated simulations. In each case,
calibrations come complete with comprehensive
documentation, training and support. The ESG
output simulations can be exported in csv or
text fle format and to databases for feeding to
downstream applications including (among
others) Igloo, Remetrica, Simulum and Risk
Explorer software platforms.
ARS AUD BRL CAD CHF CNY CZK DKK EUR
GBP INR JPY KRW MEX NOK SEK USD ZAR
4 towerswatson.com
Model Selection Table
GBP USD EUR DKK CAD SEK AUD
Interest Rates
Equity
GDP
Property
Wage Infation
Infation
Credit Spreads
FX
IR Based on Spread Over US YC
Dividend Yield
Real Rates
LIBOR Spots
Fed Funds
RPI
Indices Filter
Global_Equity
Hedge_Fund
HFRX_Absolute
HFRX_EqualWeight
HFRX_EquityHedge
HFRX_EquityMN
HFRX_EventDriven
HFRX_Macro
HFRX_RelativeValueArb
HFRX_USConvert
HFRX_USDistrssed
HFRX_USMarketDirectional
HFRX_USMergerArbitrage
HY_Global
HYEM_Sov_Credit
Private_Equity
Property_Equity
ESG control
The Star ESG library provides considerable
fexibility for users to tailor the parameterisation
of the ESG to their risk profle. The model
structure and parameters are fully transparent
and every line of code is visible. Users can
view all model inputs, change the calibration
parameters and update the starting yield curves
and rates. In addition it is possible to control
the ESG output directly using REVO, a tool
that allows users to blend their views with the
ESG. This works by re-weighting the ESG output
simulations, transforming the series towards the
target view. It is possible to set coherent targets
for multiple economic series and to specify
a path of each view. This approach has the
beneft that it is much more simple and intuitive
to use than adjusting the ESG calibration
parameters directly. REVO has been used to
align asset returns with the business plan or
fund manager return expectations and is often
used for stochastic stress test testing. This can
assess the capital impact of extreme what if?
scenarios such as a rising infation and interest
rate environments or a period of stagfation.
Figure 02. Example inputs
Star ESG 5
Figure 03. Example of results
Correlation Report
Rate
infation
Wage
Inf
Cash
Rate
GDP FX FED
Rates
Prime
Rates
1 Year
Spot
Rate
4 Year
Spot
Rate
10 Year
Spot
Rate
1Y Real
Spot
Rate
4Y Real
Spot
Rate
10Y
Real
Spot
Rate
Rate infation
100.00% 21.453% 26.560% 3.036% 5.932% 5.932% 28.798% 29.373% 35.185% -39.240% -12.842% -2.015%
Wage Inf
21.453% 100.00% 7.803% 7.919% 6.130% 6.130% 5.395% - 0.600% -2.606% -10.339% -12.275% -8.436%
Cash Rate
26.560% 7.803% 100.00% 38.412% 43.812% 43.812% 92.979% 56.663% 31.478% -16.093% 21.548% 10.004%
GDP
3.036% 7.919% 38.412% 100.00% 15.017% 15.017% 41.438% 37.939% 25.104% -16.815% 3.043% 8.445%
FX
FED Rates
5.932% 6.130% 43.812% 15.017% 100.00% 100.00% 43.529% 41.25% 25.349% -3.889% 17.708% 15.430%
Prime Rates
5.932% 6.130% 43.812% 15.017% 100.00% 100.00% 49.529% 41.257% 25.349% -3.889% 17.708% 15.430%
1 Year Spot Rate
28.978% 5.395% 92.979% 41.483% 49.529% 49.529% 100.00% 79.322% 55.836% -7.81% 37.882% 33.252%
4 Year Spot Rate
29.373% - 0.500% 56.663% 37.939% 41.257% 41.257% 79.322% 100.00% 89.549% -10.811% 42.899% 56.337%
10 Year Spot Rate
35.185% -2.606% 31.478% 25.104% 25.349% 25.349% 56.836% 89.549% 100.00% -18.130% 29.610% 51.854%
1Y Real Spot Rate
-39.240% -10.339% -16.093% -16.815% -3.889% -3.889% -7.817% -10.811% -18.130% 100.00% 67.544% 50.152%
4Y Real Spot Rate
-12.842% -12.275% 21.548% 3.043% 17.708% 17.708% 37.882% 42.899% 29.610% 67.544% 100.00% 88.446%
10Y Real Spot Rate
-2.015% -8.436% 10.004% 8.445% 15.430% 15.430% 33.252% 55.337% 51.854% 50.152% 88.446% 100.00%
1Y LIBOR Swap Rate
3.434% -3.565% 23.964% -1.112% 10.560% 10.560% 33.417% 33.821% 24.332% 31.476% 40.079% 31.671%
4Y LIBOR Swap Rate
29.825% 0.685% 61.218% 38.638% 33.695% 33.695% 80.780% 92.694% 79.247% -11.326% 37.704% 49.189%
10Y LIBOR Swap Rate
37.536% 1.375% 55.262% 39.718% 27.586% 27.586% 72.596% 88.268% 82.106% -23.390% 25.436% 40.244%
Cred Spread A 4Y
15.512% 8.678% -32.715% -35.194% -24.836% -24.836% -38.101% -50.835% -48.465% 36.298% 4.498% - 6.899%
Cred Spread AAA 4Y
-14.522% 8.587% -32.735% -33.464% -25.345% -25.345 -37.004% -48.470% -46.071% 35.965% 4.935% -5.520%
Equity Total Return
5.385% 13.567% 16.158% 39.937% 7.110% 7.110% 25.886% 36.671% 30.515% -2.554% 16.012% 27.925%
Equity Dividend Yield
-8.065% 6.050% -21.285% 29.109% -20.595% -20.595% -29.076% -39.398% -32.405% 9.763% -15.110% -23.638%
AAA
-13.930% 8.618% -32.813% -32.283% -25.471% -25.471% -36.258% -46.814% -44.404% 36.214% 5.585% -4.323%
AA
-13.634% 8.297% -32.053% -31.540% -25.693% -25.693% -36.258% -47.070% -44.743% 34.150% 3.926% -5.903%
A
-15.217% 8.746% -32.960% -34.663% -24.974% -24.794% -37.875% -50.141% -47.750% 36.603% 4.815% - 6.296%
BBB
-17.212% 8.539% -32.654% -37.911% -24.567% -24.567% -40.057% -55.182% -52.928% 36.081% 2.710% -10.066%
BB
-18.806% 7.320% -30.727% -39.751% -24.405% -24.405% -41.288% -59.696% -57.884% 32.118% -2.263% -16.228%
B
-18.712% 6.386% -27.803% -39.369% -23.510% -23.510% -41.327% - 62.211% - 60.694% 25.822% -7.738% -22.263%
CCC
-18.259% 5.627% -19.480% -38.055% -11.547% -11.547% -34.523% -55.679% -54.515% 21.181% - 6.016% -21.290%
Property
27.948% 4.031% 53.540% 30.453% 23.019% 23.019% 57.165% 43.473% 30.152% - 6.464% 24.539% 22.056%
The Star library can be deployed to clients
as a toolkit run on Towers Watsons Igloo
software platform.
6 towerswatson.com
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Term Term
EUR, 31 December 2014 USD, 31 December 2014
I 90th percentile I 75th percentile I 50th percentile I 25th percentile I 10th percentile I Mean
Figure 04. Example Projected Spot Rate Yield Curve
Asset modelling
The Star ESG library contains a suite of models
for a wide range of asset classes. The assets
are valued directly using the yield curves, credit
spreads and other economic items feeding
directly from the ESG. This preserves coherence
between the asset returns and the underlying
economic drivers from the ESG so the market
risk for the assets and liabilities will be assessed
consistently. This is essential for an holistic,
frm-level framework used for Asset Liability
Modelling (ALM) and capital setting. The asset
model simulates migrations and defaults for
every bond using the stochastic transition matrix
generated by the ESG. It is possible to model
groups of bonds and individual securities. Rules
can be specifed for the evolution of the asset
portfolio through time. The asset model provides
the option to hold bonds to maturity and then
reset them, or reset them each quarter or year.
At the end of each projection period it is possible
to rebalance assets between asset classes
and currencies.
To date the asset model includes the following
asset classes:
Government Bonds
Corporate Bonds
Floating Rate Notes
Municipal Bonds
Infation-Linked Bonds
MBS and CMO
Equities
Property
Swaps
Derivatives
Alternative assets, including hedge funds,
private equity, commodities.
Supporting regulatory compliance
The Star ESG library supports clients regulatory
submissions, including Solvency II requirements,
to understand, own and use the models. The open
architecture, transparent code and documentation
allow users to understand each model to a degree
that would be impossible in a black box setting.
The ability to control the calibration assumptions
and blend views using REVO facilitates ownership
of the modelling results an essential prerequisite
for developing the trust required to use the
model for ALM or for setting business strategy.
Star ESG users are also supported throughout the
regulatory process. Star ESG licensees receive
documentation corresponding to Solvency II
Level 1, Level 2 and Level 3 detailing models,
assumptions, limitations, calibration and
validation processes directly supporting client
Solvency II regulatory submissions. In addition
the Star ESG team has considerable experience
responding to questions and supporting
clients in regulatory meetings where helpful.

The assets are valued directly using the yield
curves and credit spreads from the ESG.
Star ESG 7
Consultancy support
Towers Watson is a leading global consultancy frm, providing tailored,
value-added investment advice. In addition to providing fnancial systems
such as Star ESG, we provide a full range of investment consulting services
to our clients, including advice in the areas of governance, investment
risk management, investment strategy, and manager selection and
monitoring. We have a global network of over 700 investment consultants.
Our professional staff is drawn from a wide variety of backgrounds and
disciplines, including actuarial work, fund management, pension scheme
management and consulting.
Why choose Star ESG?
Over 60 clients globally, including some of the largest fnancial services
providers, have chosen the Star ESG risk management framework.
Star ESG has been chosen as the ESG platform for the following
main reasons:
The technical models generate realistic outputs that can be used to
assess risk coherently in an integrated framework, whether for capital
setting, business planning or ALM.
The toolkit transfers control and understanding of the modelling to
clients because the code and architecture is transparent. The calibration
parameters are all visible and can be changed, while REVO can be used
to blend views into the ESG.
The models and documentation support regulatory submissions, including
Solvency II.
Towers Watson offers a range of consultancy and advisory services to
support the tools.
Further information
For further information, please contact:
Sam Worthington
+44 20 7227 2058
sam.worthington@towerswatson.com
Towers Watson is represented in the UK by Towers Watson Limited
and Towers Watson Capital Markets Limited.
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Copyright 2013 Towers Watson. All rights reserved.
TW-EU-2013-32294. June 2013.