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FINCAD Hosts Recent Panel on "The CVA Conundrum"
By Matthew Streeter CFA | November 3, 2013

The past several years CVA & related valuation adjustments have been an instrumental part of an ongoing and evolving global dialogue. Since the financial crisis put a spot light on the need for effective management of counterparty credit risk in OTC derivatives trading banks have attempted to calculate their Credit Value Adjustment charges under the Basel III regulatory framework and there have been many elements of these calculations that banks have found challenging to keep pace with.

FINCAD recently had the chance to host a panel discussion in New York City titled "the CVA Conundrum" that brought together several leaders at sell-side banks and close to a  hundred attendees for a thought provoking discussion highlighting some of the biggest challenges in CVA. We were grateful to have such a well-informed panel including:

  • Stephen Ahn - Managing Director, Head of Counterparty Credit Risk Modeling – BNY Mellon
  • Paul Bowmar - Managing Director, CVA – BNP Paribas
  • Troy Ovitsky - Head of CVA Trading – Wells Fargo
  • Anthony Wells - Managing Director, Markets – RBS

This October 2013 panel provided new vantage points and further visibility into this challenging area of valuation & risk analysis. Here are a few of the highlighted points coming out of discussion.

  1. There is not a one size fits all approach to managing CVA & related valuation adjustments. Throughout the panel session is was apparent that different banks are taking different approaches, whether it be to utilize cloud computation, consolidating the multiple valuation adjustments under one team (CVA, RVA, FVA) as well as the inter-dependencies with different organizational teams, such as finance, trading, IT, risk, and quantitative teams. There is a lot of variation based upon organizational structure and bank specific demands that make a cookie-cutter approach challenging at best.
  2. The need for inter-departmental collaboration is turning the traditional trading floor model of front –middle-bank office on its head. There has historically been a noticeable rift between various bank departments but now, because of the challenging nature of CVA related problems poses, among others, problems such as computational intensive calculations for multi-asset & multi-currency portfolios, an evolving required skill set for treasury & finance staff, as well as evolution of new CVA trading desks there has been a much greater need for greater collaboration. As a result, stakeholders for CVA related decision making now includes finance, trading, quant, risk, and technology decision makers. As a result finance teams have to start thinking like trading & risk and trading must also be familiar with financial concepts. Achieving organizational consensus in itself is proving to be a challenging endeavor.
  3. The need for a centralized CVA function. Based upon the magnitude of calculations, consideration to the credit modeling computations, as well as the impact of capital costs & funding costs it is apparent that the management of CVA and related valuation adjustments is best housed at the aggregate level that can oversee the CVA management across the entire bank and across all trading desks and asset classes. This is a more effective and accurate method than within the individual trading desks where wearing the responsibility for individual trading desks may misstate their contribution to enterprise wide CVA calculation and risks. So it seems apparent that this analysis is most appropriately centralized.
  4. There is a lack of global regulatory consistency in the implementation of CVA related regulations between the US & Europe. Some examples highlighted are resulting in an inconsistent regulatory framework lacking sufficient clarity for global institutions. The different interpretations and different regulatory bodies will need to be recalibrated over time as markets and these regulations continue to evolve. There is also still a lot of remaining regulatory ambiguity. One area of ambiguity discussed were the EU CVA exemptions for Risk Weighted Assets (RWA) and if they are likely to be adopted by other regulators and if so what will be the market impact of these exemptions. Another example resulting in inconsistency is the risk weighted assets calculations mandated under Basel III which can be at odds with what is required to optimize P&L calculations.
  5. Many challenges remain for banks globally in CVA related requirements ranging from computation at an organizational level, attributing profitability, as well as correctly modeling the complex relationships of credit correlations and wrong way risk. It was discussed that managing CVA and performing adequate P&L Attribution is a challenging and potentially unsolved for some banks. Additionally, it was seen as challenging for banks to adequately capture the quantitative wrong way risk in CVA models at entire aggregate level.