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Complexity increases: Managing counterparty credit risk in the swaps market  

March 2, 2016

Jamie Grant, Euromoney

The OTC derivatives market has seen several defaults in the past two decades, each of which has led to a rethink of industry practices. Nowhere is this more evident than in the evaluation of counterparty credit risk, with processes that are now unrecognizable from those of the 1980s and 1990s, when this type of risk wasn’t even factored into swap pricing. 

Managing credit exposure is particularly challenging given the demands from US and European regulators for buy-side central clearing, increased customer protection and bilateral swap margining. 

Complex requirements from the Basel Committee on Banking Supervision for Credit Valuation Adjustments (CVA) are among the factors not only driving up the costs of compliance but focusing financial institutions on the most efficient ways to deploy capital. 

Collateralization, or the margining of bilateral or cleared derivatives positions, could be a major expense. Get it wrong and you can tie up hundreds of millions of dollars in cash or collateral that could be more effectively deployed elsewhere in the bank. 

In addition to the demands of the Dodd-Frank Act and Basel III, there are new reporting and accounting standards including EMIR,  MiFID, IFRS9 and IFRS13 and FAS. Together these regulations present a massive amount of complexity that compounds operational risk in the market. Read more

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