Risk & Quant Consulting
Case study – Counterparty credit risk
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By (voluntarily) participating in the German Bundesbank’s Basel III monitoring exercise, the client contributed to the SA-CCR impact study. LPA provided support when it came to designing a new calculation methodology and running test calculations for the Basel III monitoring exercise. The method of calculating the regulatory exposure and the resulting equity requirements in terms of OTC derivatives and ETDs will change significantly under SA-CCR (Standardised Approach for Measuring Counterparty Credit Risk Exposure). SA-CCR is part of the Capital Requirements Directive and the Capital Requirements Regulation (CRD V and CRR II) to supersede the Current Exposure Method (CEM) and SM (Standardised Method).
The Strategy / Our Approach
The calculation steps required by the regulator for the quarterly reporting of derivatives portfolio data were initially prepared in an Excel spreadsheet to ensure that optimum transparency and auditability were achieved. Calculation of the capital requirements took account of the collateralisation of underlying derivatives transactions and the regulatory acknowledgement of contractually agreed netting sets. Special attention was paid to the various levels of aggregation, ranging from individual transactions, so-called hedging sets defined by SA-CCR and the different asset classes, all the way up to the counterparty level. We used our LPACalc valuation software to validate the calculations made.
At the same time, we documented the procedure in the form of a business requirements document which was used as the basis for implementing the solution in the relevant banking systems. We again used the LPACalc valuation software to verify the quality of the implementation.
We used our LPACalc software to validate the exposure calculations. The application can be used with large derivatives portfolios or with individual counterparties or derivatives. Furthermore, requisite interim results for the various levels of aggregation can be generated quickly and simply when calculating exposures under SA-CCR. This makes the calculation process transparent and allows the results to be validated easily.
In liaison with the departments involved, we managed to correctly interpret the data delivered by individual algorithms. The project results, including explicit sample calculations, were presented to the client within a business requirements document which formed the basis for implementation of the calculation solution in the bank’s own internal control process. Validation of the results of the bank’s internal implementation process was also part of the project scope and this was done using LPACalc. On top, the efficient approach also enabled us to deliver the CVA risk capital charge calculation assuming SA-CCR instead of CEM.