Canadian lender Scotiabank took a one-off hit to its trading income in the three months to end-January, after revamping the way it values uncollateralised derivatives.
The pre-tax charge of C$116 million ($87 million) was mostly absorbed by its global banking and markets division, which posted quarterly revenues of C$372 million. Without this fee or other adjustments, income would have been +21% higher.
The cause was an update to the way the bank calculates derivatives valuation adjustments (XVAs) for uncollateralised positions. The switch also had a slight impact on Scotiabank’s stressed value-at-risk measure. This increased to C$47.5 million on average for the three months to end-January, up 9% on the previous quarter, because of a jump in hedging positions under the new methodology, as well as reduced diversification of equity positions.
Who said what
“If you go back to 2014, XVA was significantly revised to include what they call funding-related adjustments at that time, but there wasn’t a standardised global approach. Over the years, market practices evolved, and we implemented a new centralised valuation platform [that] provides better modelling, data aggregation capabilities and so on. So it really reflects the adoption of an enhanced fair value methodology... very much aligned to current market practices” – Rajagopal Viswanathan, chief financial officer at Scotiabank.
What is it?
Valuation adjustment (XVA) is the umbrella term for changes made to the fair value of over-the-counter derivatives contracts, to take into account funding, credit risk and regulatory capital costs. Dealers typically incorporate the costs associated with XVAs into the price of a new trade.
Why it matters
The XVA update should provide Scotiabank with a holistic understanding of its derivatives exposures, and their related credit, debit and funding pricing adjustments. Not only does this give the firm a more realistic valuation of its positions, but it should also help in apportioning funding and capital internally to the derivatives desks.
In addition, it may help with hedging, as the bank’s trade pricing should now be more aligned with the practices of the large dealers it would typically turn to in order to offset its risks.
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Evolving XVAs – Managing changing regulation and competitive pricing
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