Risco de Cr%E9dito de Contraparte - Mark White

7/28/2019 Risco de Cr%E9dito de Contraparte - Mark White

1/31

Counterparty Credit Risk Challenges of Approach: A

Former RegulatorsPerspective

Presented October 20, 2011 at theInternational Congress of Risks,Sao Paolo, Brazil

By: Mark E. WhiteFormerly: Assistant Superintendent, Office of the Superintendent of Financial

Institutions (Canada)Member of the Basel Committee on Banking SupervisionChair of the Basel Committees Risk Management and Modelling Group


2/31

Contents

I. Background: Basel II counterparty credit risk(CCR) framework; issues from 2008/9 crisis CCR capital rules cover: OTC derivative (OTCD),

repos/other securities financing transactions (SFT) andsimilar trade exposures

II. Basel III: strengthened CCR capital requirements

A. Capital For CVA (Credit Value Adjustment) RiskB. Calibration of EAD (Exposure At Default)

C. Improved Margin Practices

D. Asset Value Correlation (AVC)

III. CCPs: Bank Exposures to Central Counterparties

GLOSSARY: see last page

- 2 -


3/31

I. Background Basel II Rules Counterparty Credit Risk (CCR) rules cover aim to:

Adequately capitalize pre-settlement risk for counterpartydefault and credit migration risk for OTCDs and SFTs

Consistent with capitalizing the business for a one year horizon Provide for cost to replace a contract with a defaulted counterparty

Create incentives & recognize risk reducing effects of:

Netting e.g. bi-lateral master agreements Collateral/margining

Central counterparties (CCPs)

Sound operational & modelling practices required tomeasure and manage risk

CCR is not market risk which is capitalized by themarket risk (trading book) rules - but markets affect CCR

e.g. how markets value credit risk, a derivative or collateral

- 3 -


4/31

I. Background Basel II Rules CCR is dynamic: OTCD, SFT and other similar trade

exposures are constantly changing due to market forces

Given stochastic nature of counterparty exposure, rules

allow either model-based or supervisory formula-basedestimates of a loan equivalent exposure via: Risk sensitive Internal Models Method (IMM); or

Standardized Method (SM) or Current Exposure Method

(CEM) IMM: uses a measure called Effective Expected Positive

Exposure (Effective EPE or EEPE) metric and an Alphamultiplier (e.g. for potential general wrong way risk)

Estimate Exposure: Rules estimate the Exposure atDefault (EAD) to be capitalized Once EAD is estimated, the risk can be capitalized

Multiple moving pieces: exposure + credit risk +

collateral are all changing, potentially in different directions- 4 -


5/31

I. Basel II CCR Capital Charge Summary

Risk sensitivity

Current

Exposure

Method(CEM)

StandardizedMethod (SM)

InternalModel

Method

(IMM)

EAD is determined on the basis of the current

exposure plus an add-on factor for thepotential future exposure

Rarely used

The bank models the exposure profile over a1-year horizon

-

+

3 methods to calculate a loan equivalent Exposure At Default (EAD) for OTCDs andSFTs - which is then input in the credit risk calculation (under SA or IRB)

Basel II CCRCapital Charge = Default risk charge

-5 -


6/31

I. CCR Issues Requiring ReformThe crisis indicated that the CCR regime needed review:1. CVA Risk: Credit valuation adjustment (CVA) losses were not

adequately capitalized no explicit CVA capital charge under Basel II

2/3 of CCR losses experienced in 2008/9 were due to CVA2. Default Risk Exposure: EEPE didnt capitalize adequately for stressperiods and wrong way risk (WWR)

3. Margining: OTCD and SFT collateral/margin requirements andpractices were sometimes inadequate

4. Correlations: More interconnected/correlated financial institution (FI)exposures than expected in IRB (internal ratings based) models

Contagion risk underestimated on a bilateral basis

5. Central Counterparties (CCPs): CCPs can mitigate bi-lateral OTCD(and SFT) risks but werent widely used; further, bank exposures toCCPs werent capitalized

G-20 requested increased OTCD standardization and use of CCPsfor standardized OTCDs

Issue: CCPs could increase risk if poorly implemented- 6 -


7/31

II. Main CCR Changes - Overview

A. Credit Valuation Adjustment (CVA) risk Create a standalone capital charge for CVA risk

Required for all CCR methods (IMM; CEM; Std)

Advanced Bond Equivalent Method (BEA) + simpler, standard method

B. Improve Internal Modelling Method (IMM) by:i. Calibrate modelled Exposure at Default (EAD) for:

Treatment of specific wrong way risk (WWR)

Stress EEPE metric (volatilities; correlations) to capitalize for stress

ii. Increase margin period of risk (MPOR) for large, complex, disputed andilliquid netting sets (trades; collateral)

Improve collateral management and stress/back-testing practices

C. Recognize interdependence between big financiers: Adjust Internal Ratings Based (IRB) formula

Add multiplier of 1.25 to the Asset Value Correlation (AVC) for IRBexposures to large regulated FIs and all unregulated FIs

- 7 -


8/31

II A. Capital for CVA Risk - Overview

Calculate CVA capital for a hypothetical bondequivalent counterparty exposure using one of twomethods Advanced CVA risk charge (ACVA) using modified

Bond Equivalent Approach (BEA)

Standardized CVA risk charge (SCVA) using pre-set

inputs Recognizes CVA as a market-type risk as creditspreads move based on risk appetiteUses market risk techniques for bond interest rates

Builds on existing methodologies for exposures andcredit spread risk implementable by 2013Consistent - not reliant on bank CVA methodologies

Applies currently available market risk constructs to CCR- 9 -


9/31

No allowance for hedges of exposures constant EAD

Hedges of exposures are too complex to model

Inconsistent industry practices for such hedging

Permits recognition of certain counterparty riskhedges

e.g. hedges where counterparty risk is offset

No reliance on black box or firm derived CVArisk models

No consistency in industry practices

Model must be supervisable and implementable Limited time before 2013 introduction

II A. Capital for CVA Overview (cont.)

- 10 -


10/31

II A. Basel III CCR Capital - SummaryBasel III CCRCapital Charge

CVA Risk Charge:

For banks without Specific RiskVaR approval for market risk.Supervisory formula approximates a1-year Value at Risk due to themovement of the counterparty creditspread.

EAD is calculated using banksmethod to calculate the CCR EAD,ie. CEM, SM or IMM.

Risksensitivity

-

Credit Valuation Adjustment(CVA) risk charge (new)

Default risk charge(based on CCR EAD) +=

CEM (as inBasel II)

IMM (enhancedrequirements from BII:eg. Stressed EEPE,treatment of wrongway risk, etc.)

SM (as inBasel II)

StandardizedCVA charge(SCVA)

Advanced CVAcharge (ACVA)

Applies to banks with approvals touse (i) IMM and (ii) Specific RiskVaR for market risk.First calculate the CVA sensitivityusing IMM; this sensitivity is thenused in VaR (market risk framework).

- 11 -

+


11/31

II A. Capital for CVA Risk - ACVAAdvanced CVA Charge (ACVA) For banks with bothIMM and Specific Risk VaR model approval Final rule achieved following consultations with ISDA +

select banks builds on original BEA proposal VaR model using bond analogy based on EAD Uses credit spread sensitivities CVA spread sensitivities based on coupon bond spreads

run through VaR model Volatile risk profiles distinguish CVA risk

Considers term structure of EEPE Requires calculation of EEPE therefore limited to IMM banks

Credit for single name and index hedges allowed Incents better hedging due to accuracy of hedge credit

These requirements only permit use of advanced CVAcharge for banks with IMM and specific risk VaR models

Standard CVA risk capital charge will need to cover other banks- 12 -


12/31

II A. Capital for CVA Risk - SCVA

Standardized CVA risk capital charge (SCVA)for all other banks

Non-IMM/non-VaR firms: cannot use ACVA risk charge

regime as they cannot model exposure and risk

ACVA requires the ability to model specific risk for a bond + EEPE

Standard CVA risk capital framework overview:

Uses only EAD, effective maturity (M) and supervisor set inputs - e.g.

credit spread + volatilities are pre-set

50% systematic correlation caps index hedge credit

Allows single name hedges for idiosyncratic risk ACVA/SCVA calibration:

Calibrated to give correct incentives e.g. reduced capital if ACVA

Calibrated to ensure reasonably consistent results and sufficientcapital to offset CVA losses (e.g. as in crisis)- 13 -


13/31

II A. Advanced & Standardized CVA Multiple QIS: results were used to calibrate/confirm

supervisory inputs in SCVA and relativity of outputs

Results achieved to capitalize for CVA risk:

Rules protect banks against CCR risk arising from changing

exposures and spreads i.e. CVA risk

Rules create correct incentives:

CVA charges generally more than double CCR capital charges whencompared to Basel II CCR default risk capital

ACVA approach generally has less than the capital of SCVA

SCVA approach using IMM has less capital than SCVA using CEM

CVA risk charge calibration is complete Effective maturities M capped at 1 year if Specific Risk VaR captures

ratings migrations

Adjust VaR model if it does not capture ratings migrations

- 14 -


14/31

NO

YES Does a Bank have anapproval for the use ofVAR model in MarketRisk Framework?

YES

Standardized CVAregime for CVA riskcapital charge, with theuse of IMM for EAD

Does a Bank

have anapproval for theuse of IMM inthe calculation ofEAD (CCRframework)?

Advanced CVA regimefor CVA risk capitalcharge, with the use ofIMM for EAD

NO

Basel II: Default Risk Capital Charge Basel III: CVA risk capitalcharge is added

Standardized CVAregime for CVA riskcapital charge, with theuse of CEM or SM for

EAD

II A. CCR Framework: Decision Tree

- 15 -


15/31

II A. CCR Summary: Default + CVA ChargesOverall CCR capital charge (default + CVA) is,depending on the bank-type, calculated as follows:

1. IMM + Specific Risk VaR banks = Advanced CVA Charge

IMM default charge (stressed EEPE) +

CVA risk Advanced CVA charge

3 x BEA VaR +

3 x BEA stress VaR (worst 1 yr in 3 yr stress period)

2. IMM + Std Approach Market Risk banks = Std CVA Charge IMM default charge (stressed EEPE) +

Standardised CVA charge (exposure via IMM)

3. Other (non-IMM) banks = Std CVA Charge

Standardised (CEM, SA) default charge + Standardised CVA charge (exposure via CEM/SM)

- 16 -


16/31

II A. Treatment of CVA P&L Losses

Potential for double counting:

With capitalization of CVA risk, a risk of double

counting exists as the CCR default chargecapitalizes for risk of loss

Cant lose $ again if CVA P&L loss has alreadyreduced retained earnings

Incurred CVA Treatment

For default risk capital charges: Deduct CVA

P&L losses (gross of DVA debit valueadjustment) from EAD for default risk Cant lose $ again - analogous to securitization FV adjustment

Gross DVA already deducted from capital

- 17 -


17/31

No credit for CVA P&L losses in CVA risk capitalcharge Banks dont reduce exposure by CVA losses

A complex calculation e.g. counterparty level

The result is generally not material to CVA risk capital CVA risk remains until exposure is substantially reduced by

losses Capital is required for the exposure next subject to write-

down

Write-downs dont reduce the likelihood of future CVA losses

QIS results: Indicated reduction of EAD by CVA incurred P&L losses

is reasonable result

Other alternatives dont result in materially differentcapital

II A. Treatment of CVA P&L Losses (cont.)

- 18 -


18/31

II B. Calibration of Modelled EAD

Stressed EEPE Background: Inadequate CCR capital held during stress

Default risk is higher if credit spreads widen

Partly due to IMM models using good times data

Similar to the need for stress VaR in trading book

CCR capital should cover stress losses given actualexposures at time of stress

Note conflict: actual & stress period exposures may differ

Historic stress period data may not reflect current risks

IMM CCR capital to be the greater of: (I) current IMMcalculation; and (II) stress period IMM calculation

Use 3 yr stress period to estimate credit default spreads

- 19 -


19/31

Stressed EEPE (cont.) Decision: principles based stress period selection

(e.g. spread increases) - similar to the downturn LGD

Stress period identified at portfolio level (notcounterparty)

Benchmarking to ensure that stress calibration is

consistent with exposures generated during stress andIMM model methods

Specific Wrong-Way Risk (WWR)

Allow banks to reflect recoveries in WWR EAD Jump-to-default risk on single name CDS = FV at risk

on underlying

II B. Calibration of Modelled EAD

- 20 -


20/31

II C. Improved Margin Practices

Crisis Experience: OTCD and SFTs could not be closed outwithin expected MPOR (margin period of risk) Current MPOR: 5 days SFTs - 10 days for OTCD

Increased MPOR for: large netting sets - exotic derivatives& illiquid collateral disputed netting sets 20 days for all netting sets that have over 5,000 trades or contain

illiquid/exotic collateral/transactions

Double margin period for 2 quarters if a netting set experiencesmaterial disputes (i.e. >2 disputes over 2Q)

The increases in IMM MPOR extend to the simpler methods (CEM,SA)

Strengthen Collateral: Securitization haircuts double (vs.corporate bonds) - re-securitizations ineligible collateral Collateral management: improve practices (e.g. downgrade

triggers; re-hypothecation) and resources

- 21 -


21/31

II D. Asset Value Correlations (AVC)

Background: IRB assumes a certain correlationbetween exposures crisis showed need for review

RMMG studies on AVCs showed AVCs for FI exposures: higher than those for non-FIs

AVCs for exposures to large FIs: higher than forsmaller FIs

Apply a 1.25 multiplier to the AVC for bankexposures to regulated and unregulated FIs Applies to all IRB exposures to FIs not just CCR

Apply multiplier to exposures to: Groups with regulated FIs and assets greater than

US$100B; and

All unregulated FIs- 22 -


22/31

III. CCPs: Overview Background: G20 instructed BCBS to create incentives for

firms to use CCPs to clear trades Basel II provided for nil exposure/capital for bank exposures to

CCPs

Very favourable but unclear scope of application

Basel III greatly increased capital for non-CCP trades

Mitigate concerns over CCPs and systemic risks by: CPSS/IOSCO rules: margining; risk management; financial

resources; stress tests; liquidity; supervision Ongoing CPSS/IOSCO dialogue with RMMG/BCBS

CPSS/IOSCO consulted on draft rules; final rules expected soon

Proper bank capitalization of exposures to CCPs

Ensure bank system holds appropriate capital for exposures Dependent on assumption that CCPs are consistently well managed,

capitalized, funded and supervised

Help to create the right incentives for all stakeholders

BCBS still finalizing capital rules for exposures to CCPs- 23 -


23/31

Compliant CCPs: Reduced capital held by a bank if acounterparty is a CCP following, and supervised under,CPSS/IOSCO standards Trade exposures/EAD receive 2% risk weight

Default exposures capitalized based on risks Non-Compliant CCPs: Exposures to non-compliant CCPs

are bilateral exposures i.e. normal CCR capital Default Fund (DF) Exposures: Bank capital for DF

exposures based on riskiness waterfall approach BCBS is evaluating risk sensitive and simple approaches

Bank capital (not CCP resource) perspective Capitalize business (not trade)

BCBS Status: Initial consultations and QIS complete

Broad consultation process after Dec 2010 paper

Revisions to Dec 2010 consultation paper proposed

Follow-up consultation on revisions expected shortly

III. CCPs: Conceptual Framework

- 24 -


24/31

- 25 -

III. Capital for Bank Exposures to CCPs

Is it a qualifying CCP?(to qualify a CCP must be: (1) subject to supervisionaccording to CPSS-IOSCO standards and (2) able to calculate KCCP)

Yes No

1250% * (prefundedcontributions + unfundedcommitments)

Exposure arising from pre-fundedcontributions

1st

step calculate Kccp (using CEM): Kccp is thehypothetical capital a CCP would hold under the bilateralCCR rules if it was a bank with CCR exposures to banks

2nd step risk sensitive waterfall approach:

determines riskiness of exposure based on CCP profile

3

rd

step allocate capital requirements to eachclearing member: based on CCP profile

B. Default Fund Exposures

Bilateral framework

applies Exposure measured using Current Exposure Method

(CEM), Internal Model Method (IMM) or StandardizedMethod (SM) depending on banks existing practices

RW = 2%

A. Trade-Related exposures(includes MtM current, plus potential future exposure, and initial and variation margin posted to the CCP)


25/31

E

KCCP

DFCCP

DFCCP

DFCCP

DFCM

DFCM

DFCM

AC

D

(iii)(ii)(i)

B

III. CCPs: Risk Sensitive DF Capital 2nd Step

- 26 -

Caption:DFccp: CCP own loss-bearing capital (from its own resources) contributed to default fundDFcm: Default fund contributions of the clearing members (CM)Kccp = (CEM Exposure amounts) * 20% * 8% = CCP hypothetical capital requirement.

This calculation is done from the CCP perspective. As such, posted initial margin and othercollateral reduce the CEM-derived exposure the CCP is assumed to have to the CMs.

Aggregate capital requirements for clearing members (CM) of a CCP dependon the CCPs own resources (DFccp) and its member-contributed resources

(DFcm) and the resulting risk using the risk sensitive waterfall approach:

Case (i) shortfall in CCP resources = 1.2 (A) + B

Case (ii) excess CCP resources from CM = C + .016 (D)

Case (iii) excess CCP resources from CCP = .016 (E)


26/31

III. CCPs: 5 Prudential Issues(I) Risk sensitive waterfall capital requirements for

default fund (DF) exposures are they accurate/fair?

Based on consistent exposure calculation across CCPs

May create information and supervisability issues

Consistently evaluates hypothetical capital a CCP wouldrequire to withstand exposures to its members if theCCP were a bank with bilateral OTCD

Takes into account initial margin/collateral

Uses the CEM method to consistently calculate the

hypothetical capital Attempts to use the CCPs actual risk profile/facts to:

consistently determine its exposures to its CMs via CEM; and

the riskiness of its CMs DF exposures to the CCP- 27 -


27/31


28/31

(IV) Indirect access to CCPs how should a bankwith indirect access capitalize its trades? Proposal: A non-CM banks trade (i.e. client trade) with

a CCP clearing member (CM), which is indirectly clearedby the CCP, may receive CCP treatment if: Assets are segregated/bankruptcy remote from CM

(segregation); and

Bank is legally assured that another CCP member will take overtrade from defaulted/insolvent CM (portability)

Otherwise, treated as bilateral exposures to the CM

Segregation is achieved under various structures, but

portability is a question Structure must substantially put client in the same position as a

CM (same incentives and assurances that trades will continue)

III. CCPs: 5 Prudential Issues (cont.)

- 29 -


29/31

(V) Why is portability necessary to receive CCPcapital treatment and can it be assured?

CMs may trade with several clients (with some offsetting

positions) and only hedge the net positionClient does not receive multi-lateral netting benefits

Can portability be assured? although it isnt commonlyassured, portability could be assured - e.g.:

CM could act as agentCCP/solvent CMs could replace trade at no-cost to client

Why isn't portability currently offered?

Even if the CMs trade with the CCP is an exact mirror of the clienttrade, the CCP (or solvent CMs) may not want to take on the risk ofthe client trade (i.e. on the same terms as the defaulting CM)

Clients do not contribute to, and therefore do not benefit from, thedefault fund of the CPP; clients CCR exposure is to its CM

No loss mutualisation if a client loses due to a CM default

III. CCPs: 5 Prudential Issues (cont.)

- 30 -


30/31

Conclusions Improved risk capture in CCR capital charges CVA capital charge: added to supplement default risk

capital charge

Advanced CVA charge for IMM + Specific Risk VaR banks Standardized charge for all others

Stress calibration for EEPE modeling to improve defaultcharge

Increased MPOR for certain netting sets to reflect longerclose-out periods

Increased AVC for FI-to-FI business to reflectinterconnectedness in the system

Promote use of CCPs Increased capital requirements for bilateral trades

Enhance bank capitalization of CCP exposures to ensure

that the banking system holds appropriate capital- 31 -


31/31

GlossaryAVC asset value correlationBCBS Basel Committee on Banking

SupervisionBEA bond equivalent approachCCP central counterparty

CCR - counterparty credit riskCDS credit default swap

CEM current exposure methodCM clearing member

CPSS/IOSCO - Committee on Paymentand Settlement Systems /International Organization ofSecurities Commissions

CVA credit valuation adjustment

DF - default fundDVA debt value adjustmentEAD exposure at defaultEEPE effective expected positive

exposureFI financial institution

- 32 -

FSB Financial Stability BoardFV fair valueIMM internal models methodIRB internal ratings based approachIRC incremental risk charge

LGD loss given defaultM - maturityMPOR margin period of riskOTCD over the counter derivatives

OTC over the counterPFE - Potential Future ExposureP&L profit and lossRMMG Risk Management &

Modelling Group

SA standardised approachSFT securities financing transactionsSM standardized methodVaR value-at-risk

WWR wrong way risk

Date post:	03-Apr-2018
Category:	Documents
Upload:	jtnylson
View:	221 times
Download:	0 times

Risco de Cr%E9dito de Contraparte - Mark White

Documents