Basel III Credit Valuation Adjustment Capital Charge and Wrong Way Risk

Authors

  • MABELLE SAYAH

Keywords:

CVA, WWR, ECM, Basel III, BA-CVA, FRTB SA-CVA

Abstract

As part of a very dynamic financial environment, regulations are always being improved
and enhanced in order to keep the financial markets as transparent and regulated as
possible. Basel is currently shifting towards central clearing of derivatives products
and amending a capital charge, Credit Valuation Adjustment (CVA) capital charge, for
those that are not cleared through Central Counterparty Clearing Houses. In this work,
a first part explains the newly proposed approaches for computing the regulatory CVA
capital requirement. Afterwards, the importance of incorporating the Wrong Way Risk
(WWR) in the computation of the CVA is detailed. An approach based on Error Correction Models highlights the differing impact of such risk for several counterparties.
Applications on interest rate swaps with a single investment grade sovereign counterparty are considered. A first conclusion discusses the divergence between the two
regulatory approaches when dealing with different counterparties within the same
risk bucket. In addition, another result is interpreted following the ECM methods reflecting the changing impact of the WWR for the counterparties considered: even for
the three European investment grade sovereigns, the model reflected a higher WWR
for Spain than the one observed for Ireland or France. A proposed modified scale for
Basel methodologies would account for the effective credit quality and WWR of each
specific counterparty in a way that converges the requested charge under both possible regulatory capital charge methodologies.

Published

2018-06-01

How to Cite

MABELLE SAYAH. (2018). Basel III Credit Valuation Adjustment Capital Charge and Wrong Way Risk. Bankers, Markets & Investors, 151(01). Retrieved from https://www.journaleska.com/index.php/bmi/article/view/315