Apr 1, 2013

Accounting for CVA across the Enterprise

Watch the Video: Accounting for CVA across the Enterprise

Pete Travnicek Regional Sales Director of Numerix joins host and CMO Jim Jockle to discuss Eleanor Hill's recent FX-MM article "CCR and CVA seeing things clearly" where they explore current trends and practices for Counterparty Credit Risk and the evolution of CVA across the enterprise. Pete and Jim address the role of collateral management in managing CVA and the challenges banks face in achieving a holistic view of risk and near real-time calculations.

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section below.

Jim Jockle (Host): It's Jim Jockle. Today talking about an article that just appeared in FX-MM written by Editor Eleanor Hill the title is called CCR and CVA seeing things clearly, and the basic summary is "Risk Management is increasingly becoming a strategic activity, as oppose to a back office burden," and with me today to talk about that of Numerix is Pete Travnicek, Financial Engineer, and former Trader on a CVA Desk. Pete how are you today.  

Pete Travnicek (Guest): I'm doing great Jim, thanks.  

Jockle: Thanks for joining us. One of the things I want to drill down on in terms of this report is focus on a study done by Lepus and it was done on behalf of a software provider of SAS and one of the key findings within this study's focus was only a mere five percent of respondents are capable of calculating CVA near real-time, and further twenty four percent were doing it intra-day. And seventy one percent were still evolving their plans. Given on your past experience, and what you're seeing today, give us a bit of the history as it relates to the way CVA is being managed, as well as those barriers of entry intro achieving real-time.     

Travnicek: Well I think CVA is so operationally intensive, to do it properly it requires numerous traditionally siloed or disparate groups to exchange information freely within an organization so if you look at a Tier I bank for example, when you start talking about trends for pricing, one area will generally cringe when talking about the other area because that means that their bonus pull will either shrink, or transfer somebody else, where in a bank, as a whole they're fine, but each individual P&L owner has a stake so that's where it becomes a political issue internally and you could have a bit of bad blood, so that's the political piece.

But then the operational piece is just gathering all of that data whether its counterparty credit rates, it's getting collateral and netting information, it's getting all of the interest rate market data, the interest rate volatility surfaces, the FX vol data, and then scrubbing all of that because, one trading desk may use, close a business marks, based on one system, or based on one set of brokers, and then another in the same organization may choose to mark their books off yet another set of curves, so synthesizing those is no easy task, so when you start talking about scrubbing data, then you throw on the political element, and we then haven't yet talked about the computationally heavy aspect of CVA, you're not just running one single calculation like you would do for P&L purposes, or a few calculations like you would do for doing Deltas or Standard Greeks, but you're doing multiple thousands of paths for each trade and then rolling those up to a single counterparty, or to a larger parent, which has a group of counterparties. It becomes a very complex issue.

Jockle: So Pete let me ask you a question. Tier I's have been actively managing CVA, through CVA desks for quite some time, and clearly they're different levels of operations, but now there's this strive to pull it all together, what are the risks if you don't, what's wrong with the old way, why can't I just set up a desk and not worry about this holistic view that you're presenting?

Travnicek: Well you're probably holding too much collateral and getting overcharged by your counterparties for your collateral, or you're creating too thin of bid offers for your trading counterparties, so all of those generally spell P&L losses, or potential for P&L losses.

Jockle: And to that point, how much are we looking at as it relates to being competitive, as it relates to your counterparties going forward?

Travnicek: Well if you ignore CVA as part of your bid offer you're going to look very competitive to many of your prospective counterparties, but you're shorting yourself in doing that, you're exposing yourself to a higher amount of risk in doing so.

Jockle: And another element of this study which was very interesting because it was looking across in terms of areas of concern of those surveyed, also indicated one of the bigger challenges were collateral management and so they broke it down into four areas, collateral management and techniques for hedging CVA, near real-time calculations and other, but collateral management is clearly in people's minds. Bring us around the connection of CVA and collateral management, why this will be roped up in the survey in this way?

Travnicek: That's a loaded question, to get a proper CVA you have to include collateral as a component of that, and because your trades are constantly changing every second and every minute of the day in as much as markets are open, or changing, and then getting all that data to flow through your system is incredibly difficult, not just because you're handing things off between this disparate systems but just because the calculations of the potential exposure are so intensive, and that's where your collateral comes in, it's not just your actual mark, it's how it's compared over previous marks, sometimes it's weighted average of multiple days or months, but then it's the potential for exposure that you're going to hold internally, so you can see how it straddles your existing exposure, and also your potential future exposure.

Jockle: Pete thank you so much for today's insight and the article again was CCR and CVA seeing things clearly written by Eleanor Hill, editor of FX-MM available online. Pete I want to thank you so much for your time and I hope you'll join us again in the future again for some more insights.

Travnicek: Thanks Jim.

Jockle: And you can follow Pete on LinkedIn as well as joining the conversation with Numerix on Twitter @nxanalytics and of course we want to hear from you, future topics going forward, you can follow our blog, or follow us on LinkedIn on the Numerix Page and on Twitter as well. We'll see you next time. Thank you Pete.

Travnicek: Thank you.    

Blog Post - Oct 20, 2011

Modeling Wrong Way Risk in CVA for Quantitative Analysts

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