July 10, 2013 - Quantifi, a leading provider of analytics, trading and risk management solutions for the global OTC markets, Ernst & Young and PRMIA recently hosted a joint seminar in London on 'Managing Counterparty Risk & Basel lll'. Over 120 senior traders and chief risk officers from leading global and regional banks who attended the seminar were surveyed to gain insight into the approaches taken towards counterparty credit risk and Basel lll.

Enhancing counterparty credit risk management practices is a key focus for banks. This is in response to changes in accounting rules and new prudential and market regulations which have tightened substantially following the financial crisis. Collectively, these changes are having a deep impact on the market and have driven banks to invest significantly in better pricing and reporting capability and in the active management of counterparty credit risk.

“Regulatory mandates continue to drive change and will have a major impact on OTC businesses for most banks. Not only does it change the way in which banks address counterparty credit risk and credit value adjustment (CVA), it will also require them to undertake significant process and system changes,” comments Dmitry Pugachevsky, Director of Research, Quantifi. “New minimum capital ratios will drive new methods of measuring and allocating capital as banks will be required to hold more capital and higher quality of capital to cover CVA risk.”

Key findings

• The majority of banks have Basel III projects in progress (71%) but are still not ready for the counterparty credit risk elements of Basel III.

• Banks continue the trend of creating centralised counterparty risk management groups (CVA desks) to more actively monitor and hedge credit risk (50%). A significant number of banks, however, continue to manage across multiple groups (35%).

• Data management (45%), performance and scalability (18%), and analytics (16%) are considered the most important components of an effective counterparty risk solution. This is consistent with earlier surveys in 2011 and 2013 by Quantifi.

Shankar Mukherjee, Senior Manager, Financial Services Advisory at Ernst & Young, comments, “Determining the fair value of derivatives contracts continues to be one of the key issues for the banking sector. The financial crisis led to significant changes in the valuation of derivatives contracts with a number of banks introducing new valuation methodologies over the last two years as assumptions that held true in the pre-crisis era have lost their validity. The new IFRS accounting standard on fair value measurement and the new charge under Basel III related to valuation adjustments as a result of credit also mean institutions have to fundamentally rethink their approach to managing counterparty credit risk.”