Jan 21, 2015

Best Practices for a Successful XVA Implementation

In our recent discussions on XVA trends we’ve explored the concepts of Trade EVA and best practices for visualizing trade profitability, in addition to bringing XVA pricing and risk into the front-office.

But, what about implementation strategy? Does your organization have a successful XVA implementation plan or organizational process yet in place?  If lingering thoughts on implementation strategy are keeping you up at night, we have some tips to share.  

Based on our research and experience, our approach advocates first viewing organizational changes from a process engineering perspective—and then, from a technology systems and quantitative model perspective.

Overall, today’s financial institutions will need to assess the many interdependencies that exist within the organization. Understanding and agreement on strategic priorities from the top-down is an essential component for any successful implementation, and should occur at the outset of the project.

Best Practices: An Iterative Approach for Process Re-engineering

blogprocessreengineering

Strategic Priorities

With respect to strategic goals, it is important to first identify relevant metrics and priorities from a business perspective. Balancing organizational goals with budgets and timelines will also be important. We’ve developed the following checklist to provide guidance in the identification process of key organizational priorities.

 

Checklist Key Organizational Priorities

Which pricing adjustments are likely to be most relevant?
Is CCP Margin Replication a priority?
What are the XVA hedging requirements?
What are the collateral management and optimization goals?
 How will the limits strategy evolve?
What are the performance requirements – daily, pre-trade/real-time, intra-day, etc.?

 
Organizational Process

Several of the initiatives we’ve outlined in this blog will require unprecedented levels of integration and collaboration between Trading, Risk, Treasury, Collateral Management and other relevant groups, for example. Naturally, significant risk of political conflicts should be expected.

In addition, new interdependencies could slow down decision-making, if not carefully designed and implemented. In some case, incentive structures will also need to be carefully reviewed and redesigned. Moreover, where to situate the XVA pricing and hedging operation (Trading, Treasury, Risk, etc.) is often a tricky question that requires discussion and resolution.

Methodology/Technical Issues

On the quantitative methodology and technology side, there are a number of success factors that will also need to be understood and addressed, per the following checklist.

Checklist Success Factors

  Data quality & cleansing (e.g. CSA Data)
  Assessment of computational needs / cloud strategy
  Appropriate measure choice (P or Q) for relevant metrics
  Avoiding numerical noise in exposures projections
  Estimating hard-to-value inputs, such as correlations
  Methodology to avoid double-counting, or unusable approximations
  Appropriate methodology for allocating costs to each trade
  Modeling all aspects of a CSA, including break clauses, rating triggers, etc.
  Appropriate ‘sanity’ checks and model risk reviews
 
For more information on XVA best practices and strategy, read our recently published white paper, Integrating Risk into Pre-Trade Analysis: Practical Ways of Bringing Credit, Liquidity, Funding & Regulatory Costs into an Integrated Profitability Framework, authored by Numerix SVP, Satyam Kancharla.
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Improving Risk Management and Transparency for Structured Products

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