A Comparative Study of Methodologies for Including Wrong-Way Risk in the Calculation of CVA [PDF]
This paper describes a selection of some of the well-known and intuitive methods for capturing wrong-way risk in CVA , in some cases with some original refinements to make them more appropriate. We analyse a selection of (real) portfolios usingeach of the methods in turn, and provide an interpretation of the different results. By using the same portfolios with differentwrong-way risk models, it is our hope to make the comparison of methodologies easier and ultimately to facilitate an informedchoice for practitioners keen to include wrong-way risk in their CVA pricing and hedging.
DVA - The Case for the Defence [PDF]
The Credit Valuation Adjustment (CVA) has been part of life for some time now, but that does not mean that everybody agrees on how it should be calculated. Apart from a fair number of practical issues which need deciding in order to calculate CVA, here is one of the fundamental questions: should it be calculated on a unilateral or bilateral basis? The former takes into account only the default probability of the counterparty, whilst the latter also considers one’s own default probability.
Bart Piron looks at why, despite all its counterintuitive effects banks should still use DVA.
Central Clearing: A New Headache for Credit Risk Managers [PDF]
The central counterparty (CCP) clearing of OTC derivatives is one of the most prominent current policy and regulatory initiatives in wholesale financial markets. This new reality is being mandated by the G-20, and is being enshrined in various pieces of legislation such as the US Dodd-Frank Act and the EU Regulation on OTC derivatives, central counterparties and trade repositories. In this context, the discipline of counterparty credit risk management will be fundamentally challenged by the introduction of central clearing. Banks will need to review their credit policies and operational processes to cope with the new central clearing paradigm.
Basel Committee on Banking Supervision – “Fundamental Review of the Trading Book” [PDF]
On 3rd May the Basel Committee on Banking Supervision (BCBS) published a consultative document with proposals to review the market risk framework under which banks calculate their regulatory capital requirements for the trading book. This represents a major change in the way banks will be asked to measure risk going forwards and comes at a time when many institutions are still struggling to implement the Basel III capital rules.
Mat Newman from SunGard’s Adaptiv and David Renz of SunGard’s Ambit provide their thoughts and insights around commonly asked questions and look at how technology plays a significant role in meeting regulatory requirements.
Basel III and Gaining IMM approval [PDF]
Banks looking to gain IMM approval have many considerations to take into account, the decisive action to proceed with IMM brings new demands for an organisation as well as providing new opportunities. Within this briefing note Richard Dyson and Andrew Williams explain the benefits and challenges of seeking Internal Model Method (IMM) approval for risk management.
Will Regulatory Change be the Death of Risk Management or its Salvation? [PDF]
The rebirth of risk management as a center for profitability
In recent times, the risk management role has changed fundamentally. For decades, risk managers have fought for recognition as strategic contributors to their respective institutions, rather than mere controllers or quantitative number crunchers. This recognition has seen risk managers engage more constructively with their trading colleagues and spend more time advising on individual activities. In this paper Sven Ludwig, SunGard’s Adaptiv investigates the strategic importance of the capabilities embedded in risk management and why the function is more important than ever before.
Why Collateral & CCPs can be Bad for your Wealth [PDF]
In order to reduce counterparty exposures in the OTC markets, a rich variety of techniques have been developed over the years. These include netting agreements, collateral agreements, termination options and bought credit protection in the form of credit default swaps or insurance. The latest one is the use of Central Counterparties (CCPs).
Although not new in principle, they recently received a lot of attention as a result of changes in regulation. Most of these techniques perform as intended most of the time, but there are cases when exposure can be increased instead of reduced as result of them. In this paper Bart Piron, Principal Consultant, SunGard’s Adaptiv explains when this is likely to happen, specifically in the case of collateral agreements and CCPs.
Closing in on the Closout Period [PDF]
The credit exposure created by OTC trading can be considerable, as many institutions found out during the credit crisis which started in 2007 and saw Lehman Brothers and a number of monoline insurers fail. Increasingly, it is not just the loss of default which is taken into account, but also the change in market value of the OTC trading book due to changes in the credit spreads, a concept known as the Credit Valuation Adjustment (CVA).
A number of techniques have been devised over time to reduce the inevitable credit exposure incurred. They include netting agreements, collateral agreements, termination options, central counterparty clearing and bought credit protection in the form of credit default swaps or insurance. In this paper Bart Piron , Principal Consultant, SunGard’s Adaptiv will be looking in some detail at the implications of collateral agreements.
Getting IMA Approval - How Important is the Choice of System? [PDF]
Opting for the internal model approach (IMA) to market risk modeling is becoming a necessity for banks. George Mutema explains how choosing the right system is vital to gaining regulatory approval for an IMA-based model.
The standardised method for calculating market risk is based on a pre-specified ‘building-block’ approach. Market risk is computed for each portfolio exposed to interest rate risk, exchange rate risk, equity risk and commodity risk. This method is highly conservative as it adds up the capital charge for each risk category and assumes that the ‘worst loss’ will hit all portfolios at the same time.
Building a CVA System Into a Bank [PDF]
SunGard Adaptiv’s Andrew Hudson examines the hidden complexities of building a CVA system into a bank and explains why it is important to develop a system that is flexible and scalable.
Credit Value Adjustment (CVA) has a simple enough definition. It is the market value of counterparty credit risk, a calculation of the difference between the risk-free valuation of a portfolio and a portfolio value incorporating the possibility of the counterparty’s default. CVA originated within banks as an accounting measure, and the introduction of accounting standard IAS39 in 2000 required banks to provide a CVA number every three months.
Credit Limits: Rubber Stamp, Stick or Carrot? [PDF]
As the role of credit limits evolves from restricting traders to supporting their risk-taking decisions, Jean-Marc Schwob, SunGard’s Product Manager for Adaptiv Credit Risk, looks at the technology needed to enable this change and asks whether credit limits will evolve to the point where they are no longer necessary.
Dodd-Frank Act: Assessing the Regulations - Market Insights [PDF]
Patrick Amon describes the likely impact of the new rules for the US banking sector.
The Dodd-Frank Wall Street Reform and Consumer Protection Act is commonly viewed as the most important piece of legislation in the US banking sector since the Great Depression of the 1930s. The act creates a number of institutional frameworks and reorganizes the federal regulatory system, but most of its impact will lie in the rules that stem from this federal reorganization.
Taking the Strain: Enterprise Collateral Management & Optimisation - Market Insights [PDF]
A huge liquidity strain and increased demand for collateral assets has made collateral management a critical component of bank’s trading activity. An enterprise-wide approach to collateral management can help banks optimise their collateral inventory, generate revenue as well as reduce costs.
Credit Valuation Adjustment: the Challenges of Implementation - Market Insights [PDF]
There are many texts on the theory of Credit Valuation Adjustment (CVA) but CVA is about much more than theory. The motivation for setting up an infrastructure to manage CVA varies considerably across institutions. The implementation of a CVA function can be highly political as it cuts across product lines and blurs the boundaries between risk management and the front office. There are also considerable systems, methodological and trading challenges. In this paper we examine some of the different motivations that have lead institutions to set up a CVA function and the practical issues they have faced.
View From The Top: Brave New Risk Management I - Market Insights [PDF]
Dedicated risk management departments may be a legal requirement but their existence alone is no guarantee for long-term survival and success. David M. Rowe and Sven Ludwig talked to more than 20 senior risk managers across Germany, Austria and Switzerland to find what lessons have been learnt from the credit crisis and the impact of forthcoming regulations and market changes. This market perspective provides a short overview of the main issues and themes gained from these interviews.
View From The Top: Here Come The Regulators II- Market Insights [PDF]
Dr. Sven Ludwig and Mat Newman spoke to more than 50 senior risk professionals as part of an ongoing study on the future of the financial services industry. Here they report on these conversations and conclude that while risk management could yet play a crucial role in the development of a new banking culture, concerns about new global regulation continue to dominate the debate.
What Comes Next for Collateral Management- Market Insights [PDF]
The SunGard/Finadium 2010 Survey on Collateral Management has identified collateral optimization and efficient collateral management as being the next big challenge for the collateral management industry. Whether facing new Basel III recommendations or looking to make processes more effective, 122 participants in the collateral management industry have clearly indicated that capital charges and optimizing the use of assets are their primary concerns. They also expect the next important advances in collateral management to occur in these areas. Technology will be a primary driver for meeting new collateral optimization mandates and solving both siloed and cross divisional challenges.
Fit for purpose? Reassessing the role of risk management - Market Insights [PDF]
As the industry reassesses the role of risk management, and keeps up with new regulatory demands, legacy systems are becoming a constraint to progress. Josie Palazzolo outlines what capabilities a modern-day risk application must possess and how advancements in technology can make these applications a reality.
A New Approach to Collateral Management - Market Insights [PDF]
Collateralisation has been a fixture in capital markets for many years and has served as a useful means for firms to both increase trading capacity whilst simultaneously mitigating counterparty credit risk. The question arises: do the techniques which worked well several years ago still work today?
Credit Charging in the Trading Book - The End of Credit Risk Management as we know it? - Market Insights [PDF]
It is becoming increasingly common for banks to charge their front office trading units for the expected losses and the capital cost of credit risk generated by their derivative trades. This charge is an internal estimate of the cost of counterparty credit risk incurred in the course of trading activities and serves as a method of encouraging the front office to manage credit exposure prudently and charge for it properly. At the same time, the credit risk so created is itself monitored, managed and hedged in the derivative markets by a desk established specifically for this function.
Wrong WayRisk II - Market insights [PDF]
Dan Travers and Jean-Marc Schwob, product managers for SunGard's enterprise risk solution Adaptiv demonstrate how credit exposure profiles could be adjusted to reflect elements of wrongway risk.In our first whitepaper we outlined a pragmatic approach to the detection of wrong-way risk situations, combining a numerical analysis of portfolio sensitivities with a judgement-based assessment of counterparties' business risk sensitivities. In this second paper we extend this argument to demonstrate how credit exposure profiles could be adjusted to reflect elements of wrong-way risk. Furthermore, we examine whether exposures should be adjusted in Basel II Pillar 1 capital calculations.
Wrong way risk is defined by the International Swaps and Derivatives Association (ISDA) as the risk that occurs when "exposure to a counterparty is adversely correlated with the credit quality of that counterparty". In short it is where default risk and exposure come together. The terms 'wrong way risk' and 'wrong way exposure' are often used interchangeably.
Ordinarily in trading book credit risk measurement, the creditworthiness of the counterparty and the exposure of a transaction are measured and modelled independently. However in a transaction where wrong way risk may occur, this approach is simply not sufficient and ignores a significant source of potential loss.
The Risk Overhaul: A new framework for risk management - Market Insights [PDF]
As the market awaits new global regulations and debates the mathematical basis for a new modeling regime, Marcus Cree argues that now is the right time to re-consider the purpose of, and the constituencies served by, risk management. Rather than starting with a new solution, maybe the real starting point is 'What is the question?'
Catastrophic Risk: Part I - Market Insights [PDF]
Anticipating and mitigating catastrophic risk: We have recently experienced an unprecedented time in the global financial markets. Not surprisingly, risk managers and the techniques they employ are under fire from market participants, regulators, financial reporters, and shareholders alike.
Default Risk: Part II - Market Insights [PDF]
Over the last week, seismic events have fundamentally altered the capital markets landscape. Weary eyed risk professionals have spent 15 hour days answering a multitude of management concerns:
Strategic Risk: Part III - Market Insights [PDF]
Strategic risk taking: Financial institutions looking to revise their risk management processes must consider a more integrated approach that gives traders and risk managers organizational parity.