In this article, David Kelly, Director of Credit Products at Quantifi, discusses how the credit crisis and regulatory responses have forced banks to update their counterparty risk management processes substantially. New regulations in the form of Basel III, the Dodd-Frank Act in the U.S. and European Market Infrastructure Regulation (EMIR) have dramatically increased capital requirements for Counterparty Credit Risk. CVA desks have been developed in response to crisis-driven regulations for improved counterparty risk management. How do these centralized groups differ from traditional approaches to manage counterparty risk, and what types of data and analytical challenges do they face?
There are three main themes inherent in these changes. First, better firmwide consolidated risk reporting has become a top priority. Second, centralized counterparty risk management groups (CVA desks) are being created to more actively monitor and hedge credit risk. Third, banks are making significant investments in technology to better support the firmwide risk reporting and CVA desk initiatives.
This article will explore some of the key changes to internal counterparty risk management processes by tracing typical workflows within banks before and after CVA desks, as well as how increased clearing due to regulatory mandates affects these workflows. Since CVA pricing and counterparty risk management workflows require extensive amounts of data, as well as a scalable, high-performance technology, it is important to understand the data management and analytical challenges involved.
CVA desks, or specialized risk control groups tasked with more actively managing counterparty risk, are becoming more prevalent, partly because banks that had them generally fared better during the crisis. To establish a basis for comparison, it is important to review counterparty credit risk pricing and post-trade risk management before the advent of CVA desks.