The Basel Committee on Banking Supervision’s (BCBS’s) consultation paper 279, published in March 2014, presented a new standardized approach for measuring counterparty credit risk exposures (SA-CCR) for over-the-counter (OTC) derivatives, exchange-traded derivatives and long settlement derivatives, building on an earlier framework known as the non-internal model method for capitalizing counterparty credit risk exposures (NIMM), described in BCBS consultation paper 254 from June 2013.
The new SA-CCR was developed in response to the weaknesses of the existing current exposure method (CEM) and the standardized method (SM) in correctly representing the risk of derivative transactions, e.g., for not being able to recognize the differences in risk level between transactions with and without daily margining. In addition, the two methods do not take enough account of the volatility level of recent stress periods in their add-on factors (for the CEM) or conversion factors (for the SM), respectively. Furthermore, the CEM is deemed to be too simple and the SM too complex with respect to netting and hedging.
The new SA-CCR will replace the existing CEM and SM to calculate the counterparty credit risk exposure. As a result, banks will have to make extensive changes to existing data repositories, to calculation methods for capital requirements and to their reporting to the regulator.
First, new data requirements must be implemented. These requirements differ significantly from the previous requirements and may therefore require access to other, previously unrelated data sources in some cases. These include, for example, information about netting agreements, such as the level of the threshold (TH), the minimum transfer amount (MTA) or the net independent collateral amount (NICA), which represents the provided and received collateral value that does not change in response to the value of the transaction it secures. Transaction-specific information will be required, such as the exercise date, exercise price and underlying for options or the attachment and detachment points for CDOs.
As a second step, the exposure at default (EAD) calculation should be implemented:
This results in changes at the processing level, which also pose challenges. Particularly with respect to determining the add-on for the potential future exposure (PFE), the approach is much more complex than is the case for the CEM. The add-on for the transactions under a netting agreement corresponds to the total of the add-ons for each so called “asset class”. The method for calculating the add-ons for each “asset class” was developed on the basis of the concept of a “hedging set”. A hedging set under the SA-CCR is a subset of transactions within an asset class that have similar attributes. Depending on the asset class, the results of netting buy and sell positions within a hedging set are partially or fully offset. The value of the add-on is thus dependent on the number of hedging sets within an asset class. This distinction is necessary in order to take account for basis risk and correlation differences within asset classes.
Another challenge is presented by the allocation of transactions to asset classes. This is based on the primary risk factors of the transaction, which must be determined correctly. In the case of certain exotic product types, it may be necessary to allocate a product to two asset classes and thus to include it in the calculation twice.
BearingPoint offers a flexible calculation engine for determining exposures in accordance with the SA-CCR and the implementation of this solution for our clients.