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Implementing a Counterparty Risk Management Process

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Quantifi explores the key challenges for banks in the implementation of counterparty risk management, focusing on data, technology and operational issues in the context of current trends and best practices.

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 credit value adjustments (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.

Recent regulatory activity has also had a profound impact on counterparty risk management, mostly due to central clearing requirements and higher capital ratios. Mandating central clearing for an expanding scope of derivative products effectively moves counterparty risk out of complex CVA and economic capital models and into more deterministic and transparent margining formulas.

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