XVA, daily settled swaps and OpRisk North America

The week on Risk.net, March 11 – 17, 2016

CVA methodology shift causes shocking $712m loss for StanChart

US END-USERS risk tax hit in move to daily settled swaps

OPRISK NORTH AMERICA sees cyber and SMA take centre stage

 

COMMENTARY: XVA – the X is for "unknown"

When Standard Chartered published its annual results on February 23, it announced it was changing the way it calculated derivatives counterparty risk, "to be in line with market practice".

The practice it adopted was the use of market data to estimate default probabilities, rather than internal or external credit ratings. It's a move other banks made a decade or more ago. In fact, one reader contacted Risk.net after the story was published to complain it dramatically understated the longevity of the practice – he had helped his employer build a market-implied credit valuation adjustment (CVA) framework in the mid-90s.

For StanChart, it's a case of 'better late than never', of course.

The annual report provides further details of the change. Forty pages after describing the new methodology, Standard Chartered breaks down the cost for the first time (on page 270 of the report): moving to the more dynamic, volatile version of CVA had forced it to write down the value of its derivatives by $712 million.

The bank claimed it was impossible for it to move sooner, citing a lack of observable market data for its Asia-heavy portfolio. That has not stopped other banks. And in a 2012 interview with Risk.net, Standard Chartered's then-head of markets gave different, more philosophical reasons not to use market data: "Looking at [credit default swaps] to determine the creditworthiness of a client doesn't seem appropriate to me," he said. "I believe most banks in Asia determine their credit appetite within their credit department by undertaking fundamental analysis of their client's financial health."

But while Standard Chartered was playing catch-up on derivatives valuation, other banks may have moved too soon. In a new, co-authored paper, Stanford University finance professor Darrell Duffie argues the $6.2 billion in losses reported by banks as a result of funding valuation adjustment (FVA) accounting should not have been taken as losses at all. The research concludes that the funding effects belong in equity, as they have no impact on fair value.

And more uncertainty surrounds credit valuation adjustment at European banks. Some are already including the cost in new trades, Risk.net has learned, even though no decision has yet been made on whether the charge needs to be applied to derivatives trades with corporate counterparties. The result has been further divergence in pricing.

 

STAT OF THE WEEK

Julius Baer paid more than $547 million to the US Department of Justice for helping US clients evade taxes. The bank opened and maintained accounts in the names of offshore entities, and provided traditional Swiss banking services that enabled US clients to hide undeclared assets.

QUOTE OF THE WEEK

"I remember having debates with other banks many, many years ago and being astounded people were still arguing that you could use historical spreads – it never came into anything we did. The idea that Standard Chartered was still doing that as recently as last year is pretty surprising" – a CVA expert.

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