Landmarks in XVA
First published:
ISBN: 9781782722939
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Managing XVA in the Ring-Fenced Bank
Robert Dargavel Smith
Introduction
Preface to Chapter 1
Being Two-Faced over Counterparty Credit Risk
Risky Funding: A Unified Framework for Counterparty and Liquidity Charges
DVA for Assets
Pricing CDSs’ Capital Relief
The FVA Debate
The FVA Debate: Reloaded
Regulatory Costs Break Risk Neutrality
Risk Neutrality Stays
Regulatory Costs Remain
Funding beyond Discounting: Collateral Agreements and Derivatives Pricing
Cooking with Collateral
Options for Collateral Options
Partial Differential Equation Representations of Derivatives with Bilateral Counterparty Risk and Funding Costs
In the Balance
Funding Strategies, Funding Costs
The Funding Invariance Principle
Regulatory-Optimal Funding
Close-Out Convention Tensions
Funding, Collateral and Hedging: Arbitrage-Free Pricing with Credit, Collateral and Funding Costs
Bilateral Counterparty Risk with Application to Credit Default Swaps
KVA: Capital Valuation Adjustment by Replication
From FVA to KVA: Including Cost of Capital in Derivatives Pricing
Warehousing Credit Risk: Pricing, Capital and Tax
MVA by Replication and Regression
Smoking Adjoints: Fast Evaluation of Monte Carlo Greeks
Adjoint Greeks Made Easy
Bounding Wrong-Way Risk in Measuring Counterparty Risk
Wrong-Way Risk the Right Way: Accounting for Joint Defaults in CVA
Backward Induction for Future Values
A Non-Linear PDE for XVA by Forward Monte Carlo
Efficient XVA Management: Pricing, Hedging and Allocation
Accounting for KVA under IFRS 13
FVA Accounting, Risk Management and Collateral Trading
Derivatives Funding, Netting and Accounting
Managing XVA in the Ring-Fenced Bank
XVA: A Banking Supervisory Perspective
An Annotated Bibliography of XVA
Following the global financial crisis a number of different regulatory bodies have proposed the ring fencing of banks, with the primary aim of making them “safe” enough to be eligible for governmental guarantees of their deposits. The UK has the Independent Commission on Banking (known as “Vickers” after its chairman), Europe has the Report of the European Commission’s High-Level Expert Group on Bank Structural Reform (the “Liikanen Report”) and the US has the Volcker rule.
While in spirit they may all agree, there are differences insofar as what activities are permitted (and with which counterparties) inside the ring-fenced banks (RFBs), and what activities must be relegated to the non-ring-fenced bank (NRFB). In particular, the Volcker rule insists on a full separation of proprietary-trading activities, which means that they must be spun off into separate companies. In order to prove that a credit value adjustment (CVA) desk is not engaging in prop trading, its hedges must be shown to be mitigating a “specific, identifiable risk”, raising some practical concerns (PwC 2014). One aspect is clear, however, and that is that all retail and small and medium-sized enterprise (SME)
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