Jean-Marc Schwob, product manager Adaptiv Credit Risk at SunGard, explained that while the SA-CCR draws on elements of the CEM and SM approach it has some key characteristics including:
- The basic counterparty exposure calculation uses a type of MTM + add-on calculation. The final result is multiplied by an 'Alpha' parameter of 1.4
- The MTM component includes the effects of net collateral, as well as collateral agreement parameters such as Thresholds, Minimum Transfer Amounts and Independent Amounts/Initial Margins. The MTM component is floored to zero at the netting set level (before the application of add-ons)
- The add-on component is calculated at the 'Hedging Set' level, and is generally based on an aggregate 'Effective Notional' amount within each Hedging Set. This allows the full or partial offsetting of long and short transactions that share common attributes, within an asset class.
- Notional amounts are weighed as follows:
- Option transactions are delta-weighted. The option delta will be calculated via a supervisory formula using supervisory volatility parameters.
- Unmargined transactions of less than 1 year will be weighted by the square root of their residual maturity (floored to 10 days)
- Margined transactions will be weighed by the square root of their Margin Period of Risk (times 1.5)
- Interest Rate and Credit Derivatives will be weighted by a ‘Supervisory Duration’ parameter reflecting the term of the underlying risk factor.
- Add-ons are fixed percentages applicable to asset classes and sub-classes.
- Add-Ons are subjected to a 'multiplier' (between 0.05 and 1), reflecting the degree of negative MTM or overcollateralisation (if any).
Schwob said there are some short-comings with the new approach as its “prescriptive nature” leaves little room for interpretation or refinements by individual banks.
“For example,” Schwob said, “the supervisory add-on and correlation factors are flat percentages applicable to broad asset classes, with no recognition of true individual asset volatilities and correlations.”
“The methodology weights interest rate and credit derivative exposures by the duration of the underlying risk factor. However no such weighting exists for FX, equity and commodity derivatives; this means that a 10-year transaction in such asset classes will have exactly the same exposure as a one year transaction.”
The move to SA-CCR means the vast majority of banks will have to adopt it, however Schwob anticipates the new methodology may see some banks seek Internal Model Method (IMM) approval instead.
“The mandatory move from CEM to SA-CCR will force banks to overhaul their counterparty exposure measurement systems. The additional complexities of the SA-CCR will come at a significant implementation cost. Therefore some banks may well decide go for IMM approval if they are going to have to change their systems anyway,” he explained.
“It should be noted, however, that the IMM approval process can be quite onerous. Moreover, some national regulators have become reluctant to even consider granting IMM approval to their local banks, due to the innate suspicion of 'black box' methodologies, especially following the financial crisis.”
The new method will take effect from January 1, 2017, in recognition of the significant change in methodology from the existing approaches, and the need for banks to adapt their policies, procedures and systems to cater for the new measure.
The Basel Committee on Banking Supervision has published its final paper on the new 'Standardised Approach for Counterparty Credit Risk’ (SA-CCR). The standardised approach will replace both the Current Exposure Method (CEM) and the Standardised Method (SM) in the Basel capital framework. So what can be expected from the new rules?