Counterparty Risk Management Analysis for Corporate Treasury

Alison Fletcher

Bloomberg LP

10:30am, 24 Apr 2018

Key Concepts

• CVA – Credit Valuation Adjustment – Difference between risk-free portfolio value and

the credit-adjusted portfolio value. The adjustment takes into account potential default.

• DVA – Debit Valuation Adjustment – Corporates own default risk.

• Bilateral – Difference between the two. Keep in mind the

worse credit is expected to default first.

Agenda

• Key concepts

• The traditional approach

• Pre-trade considerations

– Single trade DVA calculation against my own name

– Portfolio incremental calculation on my bank trades

• Post-trade considerations

• Questions

The Traditional Approach

• Corporates/banks traditionally used counterparty ratings as the major input to determine counterparty limits and credit spreads on trades.

• From their relationship banks, best price was the driving factor that Corporates used to determine who they dealt with.

• But this has been changing…

Credit Ratings

Electronic Trading Allowed Easy Determination of Additional Cost

• Logistics used to make it challenging to ask prices of banks in competition and importantly quickly work out the cost of trading of one over another.

• Electronic trading changed this. Corporates were able to easily quantify the cost of dealing with one back over another.

The 5 Year Corporate CDS is a Key Input

But what if there is no market CDS?

• As an alternative the market has been turning to a model CDS.

• Estimates the default probability.

• Ability to override key inputs with your own data.

• Used for both where the Corporate does not have a CDS but also when the Bank does not have a CDS such as some of the Canadian Banks.

Default Risk Model as market CDS Alternative

Pre-trade Considerations

Calculate Potential Credit Spread on a Single Trade

• Price up your IRS or long-dated FX trade.

• Load in your CDS curve or model CDS.

• Run DVA on this to see the credit-adjusted price.

Price up your IRS

Calculate the DVA Adjustment

Price Your FX Trade

Calculate your DVA Adjustment

Corporate Counterparty (Bank)

Limits and Risk

Electronically to keep track of Limits

Which bank reduces my exposure?

Post-trade Considerations

Reporting CVA Adjusted Valuations

Collateral as an Alternative?

• European regulation driving some corporates in this direction.

• Not as common in the US.

• Cash-rich corporates.

• Used as an alternative to paying credit spread upon trading.

Collateral Management Margin Calculation

And then Manage Disputes

Thank You!

afletcher10@bloomberg.net