Traded Market & Counterparty Credit Risk
The evolving landscape of traded market and counterparty credit risks
Since the financial crisis, there have been a number of significant evolutions in the risk management of traded portfolios. This changing landscape has meant that financial institutions have had to step up their game in the measurement and management of their Market Risks and Counterparty Credit Risks, both from a regulatory as well as an internal risk perspective.
Overhaul of the market risk framework
On the market risk side, the Basel Committee has undertaken a fundamental overhaul of the market risk framework to address significant weaknesses that led to an undercapitalisation of certain trading activities prior to the crisis. The latest rules, referred to as the fundamental review or the trading book (FRTB), introduce a new sensitivity-based standardised approach (SA) for measuring the market risk capital requirement, as well as stricter acceptance criteria for the banks opting for an internal model approach (IMA).
In the management of OTC derivatives, it has become a prevalent practise to include certain costs in the pricing of OTC derivatives that in many cases have previously been ignored. The crisis revealed that counterparty credit, funding and liquidity risks associated with OTC derivatives can be very substantial (e.g. CVA losses caused by US monoliners) and ought to be mitigated. Market participants incur counterparty credit risk hedging costs through their CVA management activities. Other costs include capital, funding and liquidity costs.
Deloitte supports financial institutions in managing the risks arising from their traded portfolios. The team assists clients across all facets of market and counterparty risk management, from providing regulatory insights to model development and implementation.
We assist organisations in assessing and developing market risk management and measurement methodologies. Our services include development and review of internal models to address key regulatory concerns, as well as end-to-end implementations. Additionally, we help financial institutions in interpreting the forthcoming regulatory changes, in particular FRTB, assessing the impacts and advising on strategies to optimise requirements.
- FRTB for structured products
The impact of an internal model under FRTB: What is the value of an internal model approach in the structured products business?
- FRTB for structured products tool
Deloitte has developed an integrated risk management solution for structured products portfolios, providing a user with a combined view of both internal risk metrics as well as regulatory capital measures. The solution integrates an internal model approach (IMA) alongside a standardised approach (SA) risk charge calculation.
Counterparty Credit Risk & XVAs
We help our clients in developing suitable models for a large variety of purposes such as: regulatory exposure calculations, XVA calculations and, stress testing. We leverage our internal solutions to provide impact assessments and benchmarks. Furthermore, the team supports organisations by providing insights on the management of risks and associated capital requirements.
- Capital management under SA-CCR
Basel III has introduced a new standardised approach for measuring counterparty credit risk (SA-CCR), which impacts both RWA and leverage ratio calculations. Going forward, banks will be faced with the strategic challenge to effectively manage capital for OTC derivatives under the new SA-CCR regime.
- Breaking down XVAs
A sensitivity-based approach for trade-level allocations
- OTC derivatives tool
Deloitte has developed an integrated OTC derivative solution that derives the relevant exposure profiles and liquidity metrics for portfolios spanning a wide range of different product classes. The tool provides a unified framework with a simultaneous full portfolio revaluation, allowing for a consistent derivation of all relevant risk metrics:
- Counterparty Credit Risk: expected positive exposure (EPE), potential future exposure (PFE)
- Liquidity Risk: expected cash flow profile, worst-case cash-flows
- OTC derivatives liquidity outflows
An industry drive towards collateralisation of OTC derivatives has sparked a shift from counterparty credit risk (CCR) towards liquidity constraints. Going forward, banks will have to closely monitor the liquidity requirements from their derivatives businesses, and can leverage their existing CCR frameworks to consistently manage liquidity risk.
Our team has in depth derivative valuations expertise, and helps clients in developing and validating their pricing models.
- Calibration and pricing using the free SABR model
Features of the free SABR model
- Stability of the SABR model
Analysis of the stability of the SABR parameters across a range of historical data.
- Risk management under the SABR model
Indications regarding the use of SABR in daily risk-management under either the Black or the Normal variant.