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“Hockey Stick” Moment for CVA Due to Regulatory and Accounting Rule Changes

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Accounting standards changes, Basel III and the development of industry best practices for risk management and valuations have caused a “hockey stick moment” for the development of credit valuation adjustment (CVA). Dan Travers, product manager for Adaptiv and CVA solutions at SunGard, explains that CVA is a fast evolving area and the last five years have seen the concept of risk adjusted pricing adapt to meet new industry requirements around derivatives transparency, and recent interest in the space from many corners of the industry has increased dramatically.

The larger investment banks in the market have been developing their CVA capabilities and, subsequently, best practices for the last 10 years, but the rest of the market is now taking an active interest in investment in this space, says Travers. However, there still remains a big disparity between the budgets firms have in place to invest in CVA infrastructure. SunGard has seen interest from the tier two firms in the market that are keen to adopt best practices and technology to improve their risk adjusted pricing methodologies.

There is also variation in the motivation behind firms’ adoption of a CVA infrastructure due to the fact it cuts across business lines, affecting both the front and middle offices. CVA can be used for a range of things such as regulatory capital management, accounting adjustment, pricing for credit risk, active counterparty risk management and for hedging purposes. SunGard examines many of these drivers and some of the hurdles to implementing a CVA architecture in its recent whitepaper.

During SunGard’s recent City Day event in London, panellists discussing the evolution of CVA noted that there has been a trend towards the development of centralised CVA desks. Robert McWilliam, managing director and global head of CVA and collateral at ING Bank, explained that his own firm has one such centralised desk that functions as a utility for these calculation for ING. Developments in the market such as more the active collateral management required by Basel III and the mark to market pricing requirements from accounting rule changes will also compel other firms to go down this route, he suggested.

Fellow panellist Alan Baxter, who is executive director at UBS, noted that his firm began its journey in 2004 to grapple with and move to CVA and mark to market methodologies. UBS adopted mark to market in 2006 and developed what he called a “centralised pot of expertise” for CVA within the firm.

Travers explains that rather than focusing on the calculations, firms are keen to use CVA to inform their strategic business decision making. “The desire is for more transparency and openness of the CVA system and more flexibility for customisation,” he says. “Due to the complexity of the calculations, a pure black box approach is only suitable for the smaller players that are keen to get in on the action. Larger firms are much more concerned with transparency.”

Given the regulatory push for increased data transparency (see recent commentary on which here), this desire to drill down into underlying input data and models is understandable. After all, if firms have to stand behind their risk calculations and appoint C level responsibility for any errors, having all the required data to hand is vital.

Travers notes that in terms of competition, in-house builds still have the largest share of the CVA market. However, a lot of risk management solution vendors are also getting in on the action; just check out recent pitches by players such as Algorithmics (see here), Fincad, Quantifi (see here) and QuIC (see here), to name just a few.

In the case of SunGard’s own CVA offering, Travers indicates that interest is coming from a diverse geographical base, but especially from the US, Europe and Australia.

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