Basel IV: Credit Valuation Adjustment risk (CVA)

Against the background that extensive losses during the financial market crisis did not arise from actual defaults of counterparties but from their deterioration in creditworthiness, Basel III introduced the CVA risk as an additional risk component.

Now, on the one hand, the previous CVA standard approach (S-CVA) is being revised and renamed the CVA basic approach (BA-CVA). The adjustments include, among other things, in addition to creditworthiness risks, the introduction of market risk components that cannot be minimised by hedging strategies, as well as a recalibration of risk weights.

In addition, a new standardised approach to CVA (SA-CVA) is introduced, which is closely aligned with the methodology of the new standardised approach to capital adequacy for market risk (FRTB) and the economic CVA calculation. The central element of the new SA-CVA are sensitivities for various risk factors, including interest rate curves, exchange rates, credit spreads, share prices and commodity prices, which makes it significantly more risk-sensitive but also methodologically and technically more complex to implement.

Finally, the Basel Committee is also dealing with the further development of the internal model approach for CVA risks; in all likelihood, however, this approach will be abolished in the future.

These proposed changes have various implications for the banks. Overall, there is a slight increase in the risks calculated according to the SA-CVA compared to the current standard approach, but a significant increase when using the BA-CVA. An adjusted calibration on the part of the supervisory authority could still reduce these effects. In addition, the application of the new CVA standard approach will involve a considerable calculation effort in determining the CVA sensitivities.

The changes to the CVA risk therefore require impact analyses and subsequently, if necessary, an optimisation of the trading portfolio as well as careful planning of the implementation. The effects of the new regulations can be optimised through various measures such as improving hedging strategies or reducing non-clearable positions in the respective portfolios. KPMG is happy to assist with the implementation of these measures.

KPMG has extensive experience at the interface between risk measurement, supervisory law and trading and IT. Our advisory services include carrying out simulations of the future capital requirement as well as designing calculations according to the selected capital approaches and their implementation and integration into the regulatory reporting system.