Challenges in Implementing a Counterparty Risk Management Process
The objectives of setting up a counterparty risk management process can be split into three categories - CVA pricing, exposure management, and regulatory requirements.

Most banks are in the process of setting up counterparty risk management processes or improving existing ones. Unlike market risk, which can be effectively managed by individual trading desks or traders, counterparty risk is increasingly being priced and managed by a central CVA desk or risk control group since the exposure tends to span multiple asset classes and business lines. Moreover, aggregated counterparty exposure may be significantly impacted by collateral and cross-product netting agreements.

Gathering transaction and market data from potentially many trading systems, along with legal agreements and other reference data, involves significant and often underestimated data management issues. The ability to calculate credit value adjustments (CVA) and exposure metrics on the entire portfolio, incorporating all relevant risk factors, adds substantial analytical and technological challenges. Furthermore, traders and salespeople expect near real-time performance of incremental CVA pricing of new transactions. Internal counterparty risk management must also be integrated with regulatory processes.

In short, the data, technological, and operational challenges involved in implementing a counterparty risk management process can be overwhelming. This paper outlines the key challenges, starting with an overview of the main business objectives, followed by a discussion of data and technology issues, and current trends in best practices.

The objectives in setting up a counterparty risk management process can be split into three categories – CVA pricing, exposure management, and regulatory requirements. CVA is the amount banks charge their counterparties to compensate for the expected loss from default. Since both counterparties can default, the net charge should theoretically be the bilateral CVA, which includes a debt value adjustment (DVA) or gain from the bank’s own default. CVA pricing can be split into the inter-bank and corporate customer markets. New legislation, including the Dodd-Frank Bill in the U.S. and the European Market Infrastructure Regulations (EMIR), along with Basel III, are mandating or incentivising clearing and increased use of collateral over CVA as the principal means for managing counterparty risk in the inter-bank market.

Request A Copy

insights

Navigate major trends & developments shaping the industry

Whitepapers

A First View on the New CVA Risk Capital Charge

The impact of the new CVA risk regulation framework on calculation methods and the infrastructure of banks could potentially be the turning point for many of the medium-sized institutes we are seeing in the market.

Whitepapers

Banks Are Not Ready for Counterparty Risk Elements of Basel lll

Basel III significantly changes the way in which financial institutions address counterparty credit risk (CCR) and credit value adjustment (CVA).

Whitepapers

CVA, DVA and Hedging Earnings Volatility

Credit Value Adjustment (CVA) is the amount subtracted from the mark-to-market (MTM) value of derivative positions to account for the expected loss due to counterparty defaults. Debt Value Adjustment (DVA) is basically CVA from the counterparty’s perspective. If one party incurs a CVA loss, the other party records a corresponding DVA gain.

Let's Talk!

Speak with one of our solution experts
Loading...