Post-2008 Basel reforms emphasized the need for robust risk management and capital underpinning of financial risks. Regulators have upped the ante for credit risk management including some securities financing transactions in the coming CVA risk capital regulation.
The impact of Basel “IV” will be much greater than initially anticipated. According to expert analysis, if banks do nothing to mitigate their impact, these rules will require them to hold billions in additional capital, while reducing the banking sector’s return on equity by 0.6 percentage points. This is a game changer for the global banking industry.
ActiveViam’s CVA Risk Capital Accelerator eases the monumental task of measuring those risks and automates calculations to optimize the capital charge. The Accelerator is delivered with a fully functional reference implementation (including dashboards that show results of each of the regulatory calculations).
For example, in line with the Standardized Approach of Fundamental Review of the Trading Book regulation, banks that have been approved to use SA-CVA need to run recurrent K optimization scenarios to see whether trades with external hedges fall under the market risk or credit risk calculation to avoid a double capital charge. In order to run scenarios on daily trade flow, a bank needs an analytical tool with What-If capabilities to understand what they need to do to reduce regulatory capital.
Banks may want to use their own models or certain file types from the pricing engine, as an example. ActiveViam provides the source code that contains pre-canned formulas to perform the calculations. Our Business Accelerators are fully customizable and users can view the results on dozens of configurable dashboards.
The new regulation is due to come into effect on January 1, 2023. Banks have an additional five years to fully implement the regulation.
Banks can use this period to position themselves for the future by designing a risk management function that can adapt to these requirements while supporting the business. ActiveViam enables users to fully leverage the bank’s own algorithms and calculations for estimating counterparty risk for each trade. Our sophisticated compression algorithms store the massive set of trajectory simulations for each trade in-memory. What’s more, our rapid-fire analysis performance is not affected by the complexity of the inputs.
According to Ernst & Young, 60% of companies expect the quality and availability of data to be the most significant challenge in delivering the Basel IV reforms.
Here are some of the key changes coming into effect:
- Revised framework
In the past, CVA capital requirements applied to all derivatives in the existing framework, except those cleared through a qualifying central counterparty and securities financing transactions (SFT) fair-valued for accounting purposes. But the revised rules require most SFTs to be included in the CVA framework, which significantly widens the compliance scope.
Furthermore, the addition of a wide range of hedges means firms can realize the capital benefit from those hedges put in place to reduce exposure to CVA risk, better aligning capital with economic risk.
- Aligning CVA with FRTB framework
Revising the CVA framework to make it more consistent with the approaches used in the revised market risk framework set out in FRTB would better align the regulatory treatment of CVA with banks’ risk management practices and result in a more cohesive framework for CVA. These measures seek to reduce the variability in capital requirements between entities that use internal models and those that do not. Along with readjusting all current internal models, firms must invest in establishing a CVA risk management framework including a separate CVA desk in order to use the SA-CVA calculation formula.
- Stringent reporting obligations
New calculations will mean new outputs and reporting needs. As a result, banks will need to ensure they can easily implement new reporting templates and quickly respond to regulatory demands for information about their trading books, exposures and own funds.This is where a comprehensive data management tool is a necessity for banks going forward. To meet this requirement, it is crucial to have a single source of information and a risk management solution that ensures efficiency. .
- Enhanced due diligence
As part of the reform, banks must take reasonable steps to assess the operating and financial performance levels and trends through internal credit analysis. This also means that due diligence should, to the extent possible, be performed at the solo entity level where there is credit exposure.
Daily monitoring of mark-to-market prices and a counterparty’s creditworthiness requires the ability to oversee and calculate thousands of fast-moving data points. Banks’ immediate priority is reviewing all existing reporting processes to ensure businesses can remain aware of their risk exposures and are compliant at all times as mandated.
What is called for is a solution that aggregates complex data sets in real-time while applying netting rules. One that delivers a convenient way of analyzing and understanding CVA at any level: across desks, currencies, counterparties, geography, and that enables rapid-fire slice & dice and drill-through leading users to discover a trade or set of trades driving the CVA.
Banks must not underestimate the impact of the new rules. Now is the time for action.
To find out how your business can benefit from real-time CVA information to ease regulatory burden, read ActiveViam’s Real-time Credit Valuation Adjustment Whitepaper.