Razor Risk Technologies has invested around the recent and growing market interest in CVA (credit value adjustment), the fair value adjustment for the cost of hedging the credit exposure across the bank's position, as required for accounting transparency and disclosure purposes.
The process of managing credit reserve, and in fact the level of the associated calculations, differ across banks in both the top tier and second tier banks. The common element across each of these institutions is the need to manage available capital. Differences in approach include:
- The extent to which CVA is managed: it can be first an assessment calculation, then a hedging strategy, and then separately a risk-externalization strategy involving contingent credit derivatives,
- The level at which the bank actively manages or warehouses assessed risk: the extent of how functions are centralised or aligned with the trading desks (i.e.: a centralised group function, or managed at a desk or group level charge from Finance),
- The extent of hedging of sensitivities (either market or credit) and how they are reconciled back to the front-office trading systems,
- Model choice (partial estimations or simulated; market-implied, or risk- neutral, historic) dependent on the level/strategy of externalization and the extent that externalized risk vehicles are marked to market,
- Scope of product/trading book coverage, range & strategies for liquid and illiquid counterparties, and the types of exposures covered,
- Scope of what risk is assessed for externalized risk and hedging purposes, based on the appetite of warehousing, and what levels of risk are to be externalized (i.e.: above the credit-limit utilisation capital relief for counterparties vs. the managing the whole counterparty exposure),
In most cases, CVA remains part of a broader capital or balance sheet management process, especially important in today's credit constrained market. The important element associated with the market's perspective for CVA is the need for a more extensive and accurate set of instrument, simulation, and attribution analytics; enabling trading teams to ultimately externalize risk at market value, rather than typical risk assessment tolerances. Razor was designed specifically to eliminate this problem, allowing the bank to calculate prices and scenarios accurately.
For further information, please contact us.