This document discusses valuation adjustments (XVAs) for over-the-counter derivatives, their relevance in Asia, and how Asian institutions are approaching them. It notes that while most Asian banks do not currently price credit valuation adjustments (CVAs) accurately, regulatory changes around capital requirements and margin rules are increasing incentives to adopt XVA frameworks. The document also outlines challenges Asian institutions face in implementing XVAs and factors that may drive more adoption, such as decreasing costs for XVA systems technology.

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FROM CVA TO XVA:
VALUATION ADJUSTMENTS TODAY AND THEIR
RELEVANCE IN ASIA
Alexandre Bon
Kuala Lumpur, May 2017

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A short history of XVAs
Mid-90’s: Birth of CVA management at JPM, BankersTrust, Goldman Sachs…
but also the Asian Financial Crisis,Wrong Way Risk, LTCM
Early 2000’s: Bilateral pricing (DVA), Actuarial (real-world) vs Active (risk-neutral) views
Accounting CVA: IAS 39, FAS 157, IFRS 13 : bilateral & market-implied
GFC: Basel 2.5 CVA Capital charge, FVA & Collateral-based pricing
Today: Accounting FVA, CCPs & OTC Margining, MVA & KVA

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OTC derivatives valuation after the GFC
SIMPLE:THE ROLE OF A BANK IS TO PROVIDE CREDIT AND FUNDING INTERMEDIATION.
The value of its assets thus depends on Credit Risk, Funding Costs & Capital constraints

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DVA
CVA
MVA
CSA-discounting
FVA
(FCA, FBA)
ColVA
LVA
XVAs: Meet the Family
CREDIT
FUNDING
CAPITAL
KVA
A COMPLEX PRICING PROBLEM
A Portfolio-level non-linear problem
Risk-neutral or real-world pricing
Data availability & maintenance
But also: ATEVA,TVA…

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Economic, accounting & regulatory viewpoints
UBIQUITOUS XVAS: ONE PRICE, MULTIPLEVALUES?
Economic value: our own “manufacturing cost”
Client pricing, Internal RiskTransfer (Fee), Economic P&L
Conventional value: “exit price”
Fair-value accounting, Collateral Management
Regulatory capital: “prudent value”, ad-hoc standards
 contextual views of DVA, FVA …
REGULATORY INCONSISTENCIES CAN COMPOUND COSTS OR OFFER DISTORTED INCENTIVES:
Accounting vs. Regulatory CVA
Imperfect recognition of risk mitigants such as:
» Initial Margin (SA-CCR floored multiplier)
» CVA exposure hedges and some credit hedges (CLNs, CDO tranches…)
EU: CVA charge exemption on Corporates
No regulatory FVA framework
Uncleared OTC: IM exemption for FX Cash transactions & CCS final notional exchanges

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XVAs: when do they matter?
If derivatives pricing is a Science, passing their manufacturing costs to final end-users is an Art…

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XVA desks come in all shapes & sizes
No pricing vs. Pricing without managing XVAs
vs. Pricing & Managing XVAs
XVA desk approach:
Actuarial (insurance) vs.Active (market) models
Scope: CVA, DVA, Funding & Collateral optimisation, Capital?
» Uncollateralised vs. all positions? Interbank vs. corporates?
» Centralised or separate XVA functions (credit/funding, asset classes, entities)?
» Relations withTreasury, Collateral Mgt, Repo desk and Risk Mgt functions
» Links with Credit Portfolio Management
» Margin & Capital costs: spot vs. forward pricing
Mandate/priorities: P&L hedging,Tail Risks, Capital reduction…
» Credit spreads: CDS single name, Index CDS, proxy-hedges, shorting of Bonds, CLN, Credit insurance
» Exposure hedges: which factors, markets… ?
» Role in unwinds & novations, compressions, signing new CSAs
» CVA securitization
Fee & risk-transfer model: no charge, upfront fee, running fee, upfront fee with premium return
Internal or client-facing?

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To hedge or not to hedge?
Today
Tomorrow

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The situation with Asian institutions
ONE STREET, MANY PRICES
Most local & regional Asian banks do not accurately price CVA
» More sophisticated institutions are transitioning to CSA-discounting
» XVA is not managed actively (except at Australian Banks and Nomura)
Global Banks actively manage XVAs
(incl. MVA & KVA at a varying degree)
SPECIFIC CHALLENGES IN ASIA
Lack of a liquid CDS market
Additional modelling challenges:
» Liquidity and data availability issues (e.g. swaptions volatilities in the local currency)
» Exposure to more risk factors (e.g. FX) than similar EU institutions
» WrongWay Risk (export-led economies, offshore funding and carry trades…)
Legal uncertainty: no-netting jurisdictions ring-fenced entities
Fragmented clearing landscape, slower pace of implementation of Margin reforms

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The situation with Asian institutions
OTHER FACTORS EXPLAINING A SLOW ADOPTION
Less capital & cash constrained than EU/US counterparts,
trading books mostly on Standardised Capital models
Uneven/slower implementation of regulations (e.g. CVA risk charge)
Fear of losing market share
Required IT and Organization investments are perceived to be significant
SOME FAVOURABLE ENVIRONMENTAL FACTORS
A number of regional institutions have recently modernised and rationalised their Capital
Markets infrastructure (e.g. integrated Front-to-Back / Front-to-Risk models)
Slower pace of adoption of regulatory reforms can be an opportunity
All in the same boat: dwindling liquidity in single-name CDS markets globally

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A wind of change?
REGULATORY DRIVERS:
Combined impacts of SA-CCR & FRTB BA-CVA charge
(BCBS 325)
FRTB SA-CVA could significantly lower CVA capital
requirements,but requires a dedicated CVA management
function
Initial Margin requirements for Uncleared OTC
derivatives
 Mitigation not fully recognised in SA-CCR
 Rising need for pre & post-trade optimisation of Margin costs
OTHER RECENT MARKET DEVELOPMENTS:
Japan CVA working group under the impulsion of the JFSA
Singaporean banks moving to CSA-discounting
Interest for CVA pricing and hedging (exposure) in Singapore &Thailand: focus on Capital more than P&L volatility
DECREASING IT COSTS FOR XVA SYSTEMS
Hardware & HPC developments (GPUs, Grid, Cloud, In-Memory aggregation…)
Algorithmic innovations (American Monte Carlo,Vectorization, Graph-oriented dependency programming,AAD…)

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The FRTB CVA charge: a potential game changer?
MOST LOCAL & REGIONAL INSTITUTIONS DO NOT HEDGE CVA:
Rewriting the current and new CVA charges for ease of comparison (no hedging):
 More conservative risk weights
 ES vs.VaR minor impact
 A sufficient incentive to consider putting in place
a CVA desk: SA-CVA and CVA hedging?
(cf. the situation in EU before corporate exemption)
 SA-CVA will bring significant relief to collateralized
portfolios (sensitivities effect)

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Why move towards an XVA framework today?
PRICING
Understand global & local players’ pricings
Avoid FVA / ColVA arbitrages
Avoid winning “bad trades” and building up concentration in riskier credits
Re-align pricing and accounting P&L
ACTIVE MANAGEMENT
Reduce Credit and CVA capital
Reduce P&L volatility
Manage Wrong Way Risk optimally (e.g. CCS,TARFs…)
Manage optimally all derivatives production costs
at the enterprise level
 CVA, FVA, MVA, KVA
 Re-align FO pricing with Treasury & Collateral operations
 Optimal collateral asset allocation
Leverage earlier regulation-driven investments

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WITH THE CONTINUOUS RISE OF OTC DERIVATIVES PRODUCTION
COSTS,TECHNOLOGY WILL BE AT THE CORE OF ASEAN BANKS’
TRANSFORMATION STRATEGIES