In this article, Rohan Douglas, CEO, Quantifi and Dmitry Pugachevsky, Director of research, Quantifi, discuss the costs of funding OTC valuation. The implementation of new regulations, including Dodd-Frank, MiFID II, EMIR and Basel III, is significantly increasing the cost of capital and forcing banks to re-evaluate the economics of their over-the-counter (OTC) trading businesses.
Market best practice implemented by the most sophisticated banks now accurately measures all the components of a trade to analyse its profitability, including credit valuation adjustment (CVA), the cost of regulatory capital and, most recently, funding valuation adjustment (FVA).
In our previous article published in Total Derivatives (The impact of FVA on swaps - A primer) we introduced FVA - Funding Valuation Adjustment - and outlined different scenarios when it has to be calculated. We also demonstrated the role of wrong-way risk, including one arising from a correlation between the default risk of a bank and its counterparty. Here we describe the on-going industry debate on how to treat FVA – as a part of risk-neutral pricing or as an extra cost of a trade.
Quantifi's 2018 Annual New York Conference
Given current market practices around counterparty risk regulation, xVA management, funding and accounting, Helaba, one of the leading German banks, decided it needed to enhance its counterparty risk infrastructure for their OTC derivatives business. To support this initiative the bank wanted to pair their existing risk and core trading infrastructure with a modern, enterprise-wide XVA solution. The ability for senior management to get a comprehensive view of the bank's counterparty risk was one of the key priorities.
Quantifi & Deloitte seminar, Frankfurt