| 11.31. | A bank must calculate regulatory CVA for each counterparty with which it has at least one covered position for the purpose of the CVA risk capital requirements.
|
| 11.32. | Regulatory CVA at a counterparty level must be calculated according to the following principles. A bank must demonstrate its compliance to the principles to SAMA.
|
| | (1) | Regulatory CVA must be calculated as the expectation of future losses resulting from default of the counterparty under the assumption that the bank itself is free from the default risk. In expressing the regulatory CVA, non-zero losses must have a positive sign. This is reflected in 11.52 where WSkhdg must be subtracted from WSkCVA.
|
| | (2) | The calculation must be based on at least the following three sets of inputs:
|
| | | a) | term structure of market-implied probability of default (PD);
|
| | | b) | market-consensus expected loss given default (ELGD);
|
| | | c) | simulated paths of discounted future exposure.
|
| | (3) | The term structure of market-implied PD must be estimated from credit spreads observed in the markets. For counterparties whose credit is not actively traded (i.e. illiquid counterparties), the market-implied PD must be estimated from proxy credit spreads estimated for these counterparties according to the following requirements:
|
| | | a) | A bank must estimate the credit spread curves of illiquid counterparties from credit spreads observed in the markets of the counterparty's liquid peers via an algorithm that discriminates on at least the following three variables: a measure of credit quality (e.g. rating), industry, and region.
|
| | | b) | In certain cases, mapping an illiquid counterparty to a single liquid reference name can be allowed. A typical example would be mapping a municipality to its home country (i.e. setting the municipality credit spread equal to the sovereign credit spread plus a premium). A bank must justify to SAMA each case of mapping an illiquid counterparty to a single liquid reference name
|
| | | c) | When no credit spreads of any of the counterparty's peers is available due to the counterparty's specific type (e.g. project finance, funds), a bank is allowed to use a more fundamental analysis of credit risk to proxy the spread of an illiquid counterparty. However, where historical PDs are used as part of this assessment, the resulting spread cannot be based on historical PD only - it must relate to credit markets.
|
| | (4) | The market-consensus ELGD value must be the same as the one used to calculate the risk-neutral PD from credit spreads unless the bank can demonstrate that the seniority of the exposure resulting from covered positions differs from the seniority of senior unsecured bonds. Collateral provided by the counterparty does not change the seniority of the exposure.
|
| | (5) | The simulated paths of discounted future exposure are produced by pricing all derivative transactions with the counterparty along simulated paths of relevant market risk factors and discounting the prices to today using risk-free interest rates along the path.
|
| | (6) | All market risk factors material for the transactions with a counterparty must be simulated as stochastic processes for an appropriate number of paths defined on an appropriate set of future time points extending to the maturity of the longest transaction.
|
| | (7) | For transactions with a significant level of dependence between exposure and the counterparty's credit quality, this dependence should be taken into account.
|
| | (8) | For margined counterparties, collateral is permitted to be recognized as a risk mitigant under the following conditions:
|
| | | a) | Collateral management requirements outlined in7.39 and 7.40 in this framework are satisfied.
|
| | | b) | All documentation used in collateralized transactions must be binding on all parties and legally enforceable in all relevant jurisdictions. Banks must have conducted sufficient legal review to verify this and have a well founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability.
|
| | (9) | For margined counterparties, the simulated paths of discounted future exposure must capture the effects of margining collateral that is recognized as a risk mitigant along each exposure path. All the relevant contractual features such as the nature of the margin agreement (unilateral vs bilateral), the frequency of margin calls, the type of collateral, thresholds, independent amounts, initial margins and minimum transfer amounts must be appropriately captured by the exposure model. To determine collateral available to a bank at a given exposure measurement time point, the exposure model must assume that the counterparty will not post or return any collateral within a certain time period immediately prior to that time point. The assumed value of this time period, known as the margin period of risk (MPoR), cannot be less than SAMA's supervisory floor. For SFTs and client cleared transactions as specified in 8.12 in this framework, the supervisory floor for the MPoR is equal to 4+N business days, where N is the re-margining period specified in the margin agreement (in particular, for margin agreements with daily or intra-daily exchange of margin, the minimum MPoR is 5 business days). For all other transactions, the supervisory floor for the MPoR is equal to 9+N business days.
|
| 11.33. | The simulated paths of discounted future exposure are obtained via the exposure models used by a bank for calculating front office/accounting CVA, adjusted (if needed) to meet the requirements imposed for regulatory CVA calculation. Model calibration process (with the exception of the MPoR), market and transaction data used for regulatory CVA calculation must be the same as the ones used for accounting CVA calculation.
|
| 11.34. | The generation of market risk factor paths underlying the exposure models must satisfy and a bank must demonstrate to SAMA its compliance to the following requirements:
|
| | (1) | Drifts of risk factors must be consistent with a risk-neutral probability measure. Historical calibration of drifts is not allowed.
|
| | (2) | The volatilities and correlations of market risk factors must be calibrated to market data whenever sufficient data exist in a given market. Otherwise, historical calibration is permissible.
|
| | (3) | The distribution of modelled risk factors must account for the possible non-normality of the distribution of exposures, including the existence of leptokurtosis (“fat tails”), where appropriate.
|
| 11.35. | Netting recognition is the same as in the accounting CVA calculations. In particular, netting uncertainty can be modelled.
|
| 11.36. | A bank must satisfy and demonstrate to SAMA its compliance to the following requirements:
|
| | (1) | Exposure models used for calculating regulatory CVA must be part of a CVA risk management framework that includes the identification, measurement, management, approval and internal reporting of CVA risk. A bank must have a credible track record in using these exposure models for calculating CVA and CVA sensitivities to market risk factors.
|
| | (2) | Senior management should be actively involved in the risk control process and must regard CVA risk control as an essential aspect of the business to which significant resources need to be devoted.
|
| | (3) | A bank must have a process in place for ensuring compliance with a documented set of internal policies, controls and procedures concerning the operation of the exposure system used for accounting CVA calculations.
|
| | (4) | A bank must have an independent control unit that is responsible for the effective initial and ongoing validation of the exposure models. This unit must be independent from business credit and trading units (including the CVA desk), must be adequately staffed and must report directly to senior management of the bank.
|
| | (5) | A bank must document the process for initial and ongoing validation of its exposure models to a level of detail that would enable a third party to understand how the models operate, their limitations, and their key assumptions; and recreate the analysis. This documentation must set out the minimum frequency with which ongoing validation will be conducted as well as other circumstances (such as a sudden change in market behavior) under which additional validation should be conducted. In addition, the documentation must describe how the validation is conducted with respect to data flows and portfolios, what analyses are used and how representative counterparty portfolios are constructed.
|
| | (6) | The pricing models used to calculate exposure for a given path of market risk factors must be tested against appropriate independent benchmarks for a wide range of market states as part of the initial and ongoing model validation process. Pricing models for options must account for the nonlinearity of option value with respect to market risk factors.
|
| | (7) | An independent review of the overall CVA risk management process should be carried out regularly in the bank's own internal auditing process. This review should include both the activities of the CVA desk and of the independent risk control unit.
|
| | (8) | A bank must define criteria on which to assess the exposure models and their inputs and have a written policy in place to describe the process to assess the performance of exposure models and remedy unacceptable performance.
|
| | (9) | Exposure models must capture transaction-specific information in order to aggregate exposures at the level of the netting set. A bank must verify that transactions are assigned to the appropriate netting set within the model.
|
| | (10) | Exposure models must reflect transaction terms and specifications in a timely, complete, and conservative fashion. The terms and specifications must reside in a secure database that is subject to formal and periodic audit. The transmission of transaction terms and specifications data to the exposure model must also be subject to internal audit, and formal reconciliation processes must be in place between the internal model and source data systems to verify on an ongoing basis that transaction terms and specifications are being reflected in the exposure system correctly or at least conservatively.
|
| | (11) | The current and historical market data must be acquired independently of the lines of business and be compliant with accounting. They must be fed into the exposure models in a timely and complete fashion, and maintained in a secure database subject to formal and periodic audit. A bank must also have a well-developed data integrity process to handle the data of erroneous and/or anomalous observations. In the case where an exposure model relies on proxy market data, a bank must set internal policies to identify suitable proxies and the bank must demonstrate empirically on an ongoing basis that the proxy provides a conservative representation of the underlying risk under adverse market conditions.
|
| | Eligible hedges
|
| 11.37. | Only whole transactions that are used for the purpose of mitigating CVA risk, and managed as such, can be eligible hedges. Transactions cannot be split into several effective transactions.
|
| 11.38. | Eligible hedges can include:
|
| | (1) | instruments that hedge variability of the counterparty credit spread; and
|
| | (2) | instruments that hedge variability of the exposure component of CVA risk.
|
| 11.39. | Instruments that are not eligible for the internal models approach for market risk under Chapter 10 to Chapter 13 of the Minimum Capital Requirements for Market Risk (e.g. tranched credit derivatives) cannot be eligible CVA hedges.
|
| | Multiplier
|
| 11.40. | Aggregated capital requirements can be scaled up by the multiplier mCVA.
|
| 11.41. | The multiplier mCVA is set at 1. SAMA may require a bank to use a higher value of mCVA if SAMA determines that the bank’s CVA model risk warrants it (e.g. if the level of model risk for the calculation of CVA sensitivities is too high or the dependence between the bank’s exposure to a counterparty and the counterparty’s credit quality is not appropriately taken into account in its CVA calculations).
|
