XVA and Collateral: pricing and managing new liquidity

risks

Andrew Green

5th April 2016

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Disclaimer

The views expressed in this presentation are the personal views of the
speaker and do not necessarily reflect the views or policies of current or
previous employers.

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comments of the speakers.

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Outline of the Presentation

1 XVAs Defined

2 XVAs and Collateral

3 Discounting Methodology vs. ColVA

4 Initial Margin and MVA

5 Economic vs Accounting vs Regulatory Valuations

6 Risk Limits

7 Bibliography

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 XVAs Defined

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XVAs Defined

XVA Definition
CVA counterparty credit risk
DVA own credit risk - often seen as overlapping FBA
FBA funding benefit
FCA funding cost
FVA = FBA + FCA
ColVA difference between collateral return and risk-free rate (OIS)
KVA (regulatory) capital costs
MVA cost of initial margin
TVA tax
RVA replacement of derivative on downgrade
NVA(?) negative rates(?)

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One possible model: Burgard-Kjaer funding strategy 1

Valuation adjustment U takes the form:

U =CVA + DVA + FCA + COLVAX + COLVAIC

+ MVA + KVA + TVAE + TVAC

where each term takes the form

T
Et [(u) ]du
Z Ru
(s)ds
XVA(, , , ) = (u )e t

and the parameter values are given in the table below.

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XVA parameters

XVA Valuation
Adjustment
CVA (1 RC )C r + C + B V (u ) + Credit
FVA sF ditto V (u ) Funding
COLVAX sX ditto X (u ) Collateral
COLVAIC rIC ditto IC (u ) Margin
KVA K rB ditto K (u ) Capital
MVA s F s IB ditto IB (u ) Margin
TVAE E ditto E (u ) Tax
TVAC C (1 )(1 ) ditto E
Tax
Table: The parameter values in the generic XVA integral for the funding strategy 1
and standard close-out conditions.

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 XVAs and Collateral

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XVAs and Collateral

XVA Option- OIS / Cash Xccy IM LCR / Lever-

ality Repo sprds basis NSFR age
basis
CVA 3 3
DVA 3 3
FBA 3 3 3 3
FCA 3 3 3 3
ColVA 3 3 3 3 3
KVA 3 3 3 3
MVA 3 3 3 3 3
RVA 3 3 3 3 3 3 3

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 Discounting Methodology vs. ColVA

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Discounting Methodology vs. ColVA

How do we model Collateral in Derivative Valuation?

Discounting Approaches
CSA discounting - [24]
Multi-currency collateral - [25] and [4]
Sticky Collateral - [26]
ColVA
ColVA - [15]
Multi-currency effects - [22]

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 Initial Margin and MVA

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Initial Margin and MVA

Initial Margin Appears in 2 Contexts:

CCPs
Bilateral Margin - BCBS-IOSCO [10]
Modelling MVA
MVA Defined + Methodology for VaR / ES IM - [20]
MVA for SIMM - [27]

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Economic vs Accounting vs Regulatory Valuations

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Economic vs Accounting vs Regulatory Valuations

Considerable tension between valuations in different contexts

Economic Value
Easiest to define - all in XVA treatment but reflecting banks own costs
Accounting Value
CVA (bilateral in many case)
FVA (40+ banks have taken reserves)
(Still!) debate about FVA and accounting - [1, 2, 16, 3]
Debate around KVA accounting - [21]
Regulatory Value
Unilateral CVA included - [7, 11, 14]
DVA, FVA etc - excluded - [6]
Europe EBA: Capitalisation of prudent valuation [17]

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 Risk Limits

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Risk Limits

Traditional
Market Risk: VaR, Stress Tests
Credit Risk: PFE, Stress Tests
Regulatory Implied
Market Risk - Basel 2, FRTB [5, 13, 11, 14]
Credit Risk - Basel 3, SA-CCR [7, 12]
Stress - EBA stress tests, DFAST and CCAR
Leverage Ratio [7, 18, 19, 23]
Funding / Liquidity - LCR, NSFR [8, 9]

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 Bibliography

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Bibliography I

[1] Claudio Albanese.

Accounting for otc derivatives: Funding adjustments and the
re-hypothecation option.
SSRN, 2014.
[2] Claudio Albanese, Leif B. G. Andersen, and Stefano Iabichino.
Fva accounting, risk management and collateral trading.
Risk, 28(2), 2015.
[3] Leif B. G. Andersen, Darrell Duffie, and Yang Song.
Funding Value Adjustments.
SSRN, 2016.
[4] Alexandre Antonov and Vladimir Piterbarg.
Options for collateral options.
Risk, 27(3), 2014.

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Bibliography II

[5] BCBS.
International Convergence of Capital Measurement and Capital
Standards.
Bank for International Settlements, 2006.
[6] BCBS.
Application of own credit risk adjustments to derivatives - consultative
document.
Bank for International Settlements, December 2011.
[7] BCBS.
Basel III: A global regulatory framework for more resilient banks and
banking systems.
Bank for International Settlements, 2011.

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Bibliography III

[8] BCBS.
Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring
tools.
Bank for International Settlements, 2013.
[9] BCBS.
Basel III: the Net Stable Funding Ratio.
Bank for International Settlements, 2014.
[10] BCBS.
Margin requirements for non-centrally cleared derivatives.
Bank for International Settlements, 2015.
[11] BCBS.
Review of the Credit Valuation Adjustment (CVA) risk framework -
consultative document.
Bank for International Settlements, 2015.

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Bibliography IV

[12] BCBS.
Revisions to the Standardised Approach for credit risk.
Bank for International Settlements, 2015.
[13] BCBS.
Minimum capital requirements for market risk.
Bank for International Settlements, 2016.
[14] BCBS.
Reducing variation in credit risk-weighted assets - constraints on the
use of internal model approaches.
Bank for International Settlements, 2016.
[15] Christoph Burgard and Mats Kjaer.
Funding Strategies, Funding Costs.
Risk, 26(12):8287, December 2013.

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Bibliography V

[16] Christoph Burgard and Mats Kjaer.

Derivatives Funding, Netting and Accounting.
In Chris Kenyon and Andrew Green, editors, Landmarks in XVA,
pages 545556. Risk Books, 2016.
[17] EBA.
Consulation Paper: Draft Regulatory Technical Standards (RTS) On
prudent valuation under Article 105(14) of Regulation (EU) 575/2013
(Capital Requirements Regulation - CRR).
European Banking Authority, 2013.
[18] EBA.
Commission Implementing Regulation (EU) No 680/2014 of 16 April
2014 laying down implementing technical standards with regard to
supervisory reporting of institutions according to Regulation (EU) No
575/2013 of the European Parliament and of the Council.
European Banking Authority, 2014.
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Bibliography VI

[19] EBA.
EBA Final draft Implementing Technical Standards on disclosure of
the leverage ratio under Article 451(2) of Regulation (EU ) No
575/2013 (Capital Requirements Regulation CRR).
European Banking Authority, 2014.
[20] Andrew Green and Chris Kenyon.
MVA: Initial Margin Valuation Adjustment by Replication and
Regression.
Risk, 28(5), 2015.
[21] Richard David Kenyon and Chris Kenyon.
Accounting for kva under ifrs 13.
Risk, 29, March 2016.

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Bibliography VII

[22] Mats Kjaer.

Multi-Currency Funding With All The Trimmings.
WBS 5th Annual Initial Margin, XVA & KVA Conference, 2016.
[23] Office of the Comptroller of the Currency, Treasury; the Board of
Governors of the Federal Reserve System; and the Federal Deposit
Insurance Corporation.
Regulatory Capital Rules: Regulatory Capital, Revisions to the
Supplementary Leverage Ratio.
Federal Register, 79(187):5772557751, September 2014.
[24] Vladimir Piterbarg.
Funding beyond discounting: collateral agreements and derivatives
pricing.
Risk, 23(2):97102, 2010.

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Bibliography VIII

[25] Vladimir Piterbarg.

Cooking with Collateral.
Risk, 25(8), August 2012.
[26] Vladimir Piterbarg.
Stuck with collateral.
Risk, 26(11), 2013.
[27] Ignacio Ruiz.
Dynamic SIMM via Algorithmic Greeks Acceleration (AGA).
iRuiz Technologies, 2016.

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