Basel Committee on

Banking Supervision

MAR
Calculation of RWA for
market risk
MAR50
Credit valuation adjustment
framework
Version effective as of
15 Dec 2019
First version in the format of the consolidated
framework.

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© Bank for International Settlements 2019. All rights reserved.

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Credit valuation adjustment risk capital requirement
50.1 The risk-weighted assets (RWA) for credit valuation adjustment (CVA) risk are
determined by multiplying the capital requirements calculated as set out in this
chapter by 12.5.

50.2 In addition to the default risk capital requirements for counterparty credit risk
determined based on the standardised or internal ratings-based (IRB) approaches
for credit risk, a bank must add a capital requirement to cover the risk of mark-to-
market losses on the expected counterparty risk (such losses being known as
CVA) to over-the-counter (OTC) derivatives. The CVA capital requirement will be
calculated in the manner set forth below depending on the bank’s approved
method of calculating capital requirements for counterparty credit risk and
specific interest rate risk. A bank is not required to include in this capital
requirement:

(1) transactions with a qualifying central counterparty; and

(2) securities financing transactions (SFTs), unless their supervisor determines

that the bank’s CVA loss exposures arising from SFT transactions are
material.

FAQ
FAQ1 Can the Basel Committee clarify whether the 1.06 scaling factor
applied to RWA for credit risk CRE30.4 will apply to the CVA RWA
category? Our expectation is that the calculation of CVA RWA is a
market risk calculation and the 1.06 scaling factor should not be
applied.

The 1.06 scaling factor does not apply. The CVA volatility formula
multiplied with the factor 3 (under the quantitative standards described
in MAR30.16) produces a capital number directly, rather than an RWA.
Multiplying the CVA volatility charge by 12.5 to get an RWA equivalent
would then not involve the 1.06 scalar.

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 FAQ2 The counterparty credit risk rules in CRE50 to CRE55 include a number
of areas that have not previously received regulatory scrutiny. Does the
Basel Committee consider that supervisory approvals will be required
for Basel III, specifically in the areas of: (1) proxy models in respect of
credit default swap (CDS) spread used where no direct CDS available;
(2) applicability of index hedges to obtain the base 50% offset of the
new CVA capital requirement; (3) if the basis risk requirement for index
hedges is sufficient to satisfy the supervisor, will this automatically
enable a 100% offset or is it intended to be a sliding scale between
50% and 100%; (4) overall system and process infrastructure to deliver
the Basel III changes, even if covered by existing approved models and
processes; (5) choice of stress periods to ensure industry consistency (in
this regard, for value-at-risk, or VaR, calculation purposes, how should
the one year period within the three year stress period be identified);
and (6) the fundamental review of the Trading Book will include further
analysis of the new CVA volatility charge - is there any indication as to
implementation date and, in the meantime, should CVA market risk
sensitivities be included in the bank’s VaR calculation.

The use of an advanced or standardised CVA risk capital requirement

method depends on whether banks have existing regulatory approvals
for both internal models method and specific risk of debt instruments
in their VaR model. Supervisors will review each element of banks’ CVA
risk capital requirement framework based on each national
supervisor's normal supervisory review process.

FAQ3 How should purchased credit derivative protection against a banking

book exposure that is subject to the double-default framework CRE32.
27 or the substitution approach CRE22.32 to CRE22.34 be treated in
the context of the CVA capital requirement?

Purchased credit derivative protection against a banking book

exposure that is subject to the double default framework (CRE32.27) or
the substitution approach (CRE22.32 to CRE22.34) and where the
banking book exposure itself is not subject to the CVA capital
requirement, will also not enter the CVA capital requirement. This
purchased credit derivative protection may not be recognised as hedge
for any other exposure. (This is consistent with CRE51.16 that says that
the exposure at default, or EAD, for counterparty credit risk from such
instruments is zero. It is also consistent in the sense that hedging
should not increase the capital requirement.)

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 FAQ4 How should purchased credit derivative protection against a
counterparty credit risk exposure that is subject to the double-default
framework (CRE32.27) or the substitution approach (CRE22.32 to
CRE22.34) be treated in the context of the CVA capital-charge?

For purchased protection against a counterparty credit risk exposure

that is itself subject to the CVA capital requirement, the procedure is
analogous to the substitution approach. That is:

a)       in the advanced CVA charge, the exposure time-profile (EE_i) of

the original counterparty credit risk gets reduced by the protected
amount and the exposure profile to the protection seller gets increased
by the amount for which it has sold protection. This substitution is
done for time buckets whose valuation time (t_i) is smaller than the
maturity of the purchased protection but not for the buckets with
larger valuation times.

b)      In the standardised CVA capital requirement, the protected

amount times the residual maturity of the protection gets deducted
from the M x EAD of the original counterparty credit risk and added to
the M x EAD of the protection seller.

Alternatively, if the purchased protection is an eligible hedge within the

CVA capital requirement (MAR50.13 and MAR50.14), then the credit
protection may be recognised as a CDS hedge as specified in the rules
for the CVA capital requirement. In the latter case, the CVA capital
requirement must also reflect the CVA-risk of the credit protection.
That is, despite CRE51.16 which still applies in the context of the
default-risk charge, the counterparty credit risk exposure towards the
protection seller may not be set to zero in the context of the CVA
capital requirement.

FAQ5 Is a bank required to calculate the CVA capital requirement daily?

Banks should discuss the frequency with which the CVA capital
requirement needs to be computed with their national supervisor. To
receive regulatory approval to use the advanced CVA approach, banks
are generally expected to have the systems’ capability to calculate the
CVA capital requirement on a daily basis, but would not be expected or
required to calculate it on a daily basis. Instead, banks are required to
calculate the CVA capital requirement at least on a monthly basis in
which expected exposure is also required to be calculated. In this case,
banks are to calculate VaR and stressed VaR by taking the average
over a quarter.

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 FAQ6 We seek clarification of whether the reduction in EAD by incurred CVA
extends to the calculation of expected loss amounts for banks applying
IRB risk weights. We would expect the reduction in EAD to be extended
to expected loss (EL) but this would necessitate amendments to other
requirements (eg CRE35.2). Could the Committee confirm that
amendments to the calculation of CVA risk and default risk capital will
be clarified to refer to expected loss capital deduction as well as RWA?

The Committee confirms that, after the quantitative impact study

undertaken after the release of the Basel III Accord, incurred CVA will
be recognised as a reduction in EAD when calculating the default risk
capital. Incurred CVA is not permitted to be counted as eligible
provisions under CAP30.13, ie banks that are currently recognising
CVA as general provisions to offset expected loss in the IRB framework
should no longer count CVA as provisions. Nevertheless, EL can be
calculated based on the reduced “outstanding EAD” which reflects
incurred CVA (see CRE51.12). That is, for derivatives, the EL is
calculated as PD*LGD*(outstanding EAD).

FAQ7 Could the treatment of defaulted exposures in terms of CVA capital

requirement and incurred CVA be clarified?

Banks are not required to calculate the CVA capital requirement for
defaulted counterparties, where the loss due to default has been
recognised for accounting and reporting purposes and provided that,
as a result of the default, the derivative contracts have been
transformed into a simple claim and no longer have the characteristics
of a derivative.

FAQ8 Is an intercompany transaction with a zero risk weight subject to a

CVA capital requirement? Industry members would like confirmation
on a technical note that, as with the downgrade-and-default charge
within the Basel II framework, the CVA-variability charge associated
with affiliate exposures will net out under group consolidated reporting.

As per the group consolidated reporting, no regulatory capital

requirement (including a CVA capital requirement) applies to
intercompany transactions. This should include the relevant CVA hedge
that is only with an internal desk; internal hedges are not recognised
for regulatory capital purposes because they are eliminated in
consolidation.

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Advanced CVA risk capital requirement
50.3 Banks with internal models method (IMM) approval for counterparty credit risk
and approval to use the market risk internal models approach for the specific
interest-rate risk of bonds must calculate this additional capital requirement by
modelling the impact of changes in the counterparties’ credit spreads on the
CVAs of all OTC derivative counterparties, together with eligible CVA hedges
according to MAR50.12 to MAR50.14, using the bank’s VaR model for bonds. This
value-at-risk (VaR) model is restricted to changes in the counterparties’ credit
spreads and does not model the sensitivity of CVA to changes in other market
factors, such as changes in the value of the reference asset, commodity, currency
or interest rate of a derivative. Regardless of the accounting valuation method a
bank uses for determining CVA, the CVA capital requirement calculation must be
based on the following formula for the CVA of each counterparty, where:

(1) ti is the time of the i-th revaluation time bucket, starting from t0=0.

(2) tT is the longest contractual maturity across the netting sets with the
counterparty.

(3) si is the credit spread of the counterparty at tenor ti, used to calculate the
CVA of the counterparty. Whenever the credit default swap (CDS) spread of
the counterparty is available, this must be used. Whenever such a CDS
spread is not available, the bank must use a proxy spread that is appropriate
based on the rating, industry and region of the counterparty.

(4) LGDMKT is the loss-given-default of the counterparty and should be based

on the spread of a market instrument of the counterparty (or where a
counterparty instrument is not available, based on the proxy spread that is
appropriate based on the rating, industry and region of the counterparty). It
should be noted that this LGDMKT, which inputs into the calculation of the
CVA risk capital requirement, is different from the loss-given-default (LGD)
that is determined for the IRB and counterparty credit risk (CCR) default risk
charge, as this LGDMKT is a market assessment rather than an internal
estimate.

(5) The first factor within the sum represents an approximation of the market
implied marginal probability of a default occurring between times ti-1 and ti.
Market implied default probability (also known as risk-neutral probability)
represents the market price of buying protection against a default and is in
general different from the real-world likelihood of a default.

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 (6) EEi is the expected exposure to the counterparty at revaluation time ti, as
defined in CRE53.12 (regulatory expected exposure), where exposures of
different netting sets for such counterparty are added, and where the
longest maturity of each netting set is given by the longest contractual
maturity inside the netting set.

(7) Di is the default risk-free discount factor at time ti, where D0 = 1.

FAQ
FAQ1 MAR50.3 permits the use of proxy CDS spreads. As the majority of
banks have portfolios that extend well beyond the scope of bond
issuers, proxying a CDS spread will be the norm rather than the
exception. We consider this approach to be acceptable given an
appropriate model. Is this correct?

Yes, that is correct. To the extent that single-name CDS spread data is
not available, banks should use a proxy spread, the methodology for
determining the proxy being part of the approved internal model for
specific interest rate risk.

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 FAQ2 We seek clarification of the calculation of LGD for the purposes of
MAR50.3 where market instruments or proxy market information is not
available). For example, for sovereign entities the identification of a
market spread or a proxy spread is often not possible other than in
distressed scenarios. Also, we seek clarity on how to take into account
potential security packages or other credit enhancement provisions
that could be available in the Credit Support Annex or the trade
confirmation.

While the Committee recognises that there is often limited market

information of LGDMKT (or equivalently the market implied recovery
rate), the use of LGDMKT for CVA purposes is deemed most appropriate
given the market convention of CVA. As it is also the market
convention to use a fixed recovery rate for CDS pricing purposes, banks
may use that information for purposes of the CVA risk capital
requirement in the absence of other information. In cases where a
netting set of derivatives has a different seniority than those derivative
instruments that trade in the market from which LGDMKT is inferred, a
bank may adjust LGDMKT to reflect this difference in seniority. Note
that bank specific risk mitigants are not used for this calculation.

FAQ3 MAR50.3 states: “Whenever such a CDS spread is not available, the
bank must use a proxy spread that is appropriate based on the rating,
industry and region of the counterparty.” For counterparties (eg small
or medium-sized entities) where no market data is available, neither
CDS spreads nor traded debt, VaR modelling based on proxy index
spreads is hard to validate. Is it left to the national supervisor to decide
whether these may be modelled in advanced CVA or should
standardised CVA be compulsory? The recognition of index hedges is
very different in advanced CVA and standardised CVA, so this could
lead to material differences in implementation.

Yes, it is left to national supervisors to decide.

FAQ4 The regulatory CVA formula contains the terms EEi and Di which
assume in the case of interest rate related exposures (eg interest rate
swaps) that the discount factor and IR exposures are independent. Is
the bank allowed to replace the terms EEi x Di by E [discount factor x
max (0, V(t))]?

No, the regulatory formula is not to be changed.

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50.4 The formula in MAR50.3 must be the basis for all inputs into the bank’s approved
VaR model for bonds when calculating the CVA risk capital requirement for a
counterparty. For example, if this approved VaR model is based on full repricing,
then the formula must be used directly. If the bank’s approved VaR model is
based on credit spread sensitivities for specific tenors, the bank must base each
credit spread sensitivity on the following formula:

50.5 This derivation of the formula in MAR50.3 assumes positive marginal default
probabilities before and after time bucket ti and is valid for i<T. For the final time
bucket i=T, the corresponding formula is as follows:

50.6 If the bank’s approved VaR model uses credit spread sensitivities to parallel shifts
in credit spreads (Regulatory CS01), then the bank must use the following
formula (the derivation of which assumes positive marginal default probabilities):

50.7 If the bank’s approved VaR model uses second-order sensitivities to shifts in
credit spreads (spread gamma), the gammas must be calculated based on the
formula in MAR50.3.

50.8 Banks with IMM approval for the majority of their businesses, but which use the
standardised approach for counterparty credit risk (SA-CCR) for certain smaller
portfolios, and which have approval to use the market risk internal models
approach for the specific interest rate risk of bonds, will include these non-IMM
netting sets into the CVA risk capital requirement, according to MAR50.3, unless
the national supervisor decides that MAR50.15 should apply for these portfolios.
Non-IMM netting sets are included into the advanced CVA risk capital
requirement by assuming a constant expected exposure (EE) profile, where EE is
set equal to the exposure-at-default (EAD) as computed under the SA-CCR for a
maturity equal to the maximum of: (i) half of the longest maturity occurring in the
netting set; and (ii) the notional weighted average maturity of all transactions
inside the netting set. The same approach applies where the IMM model does
not produce an EE profile.

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50.9

For exposures to certain counterparties, the bank's approved market risk VaR
model may not reflect the risk of credit spread changes appropriately, because
the bank's market risk VaR model does not appropriately reflect the specific risk
of debt instruments issued by the counterparty. For such exposures, the bank is
not allowed to use the advanced CVA risk charge. Instead, for these exposures
the bank must determine the CVA risk charge by application of the standardised
method in MAR50.15 and MAR50.16. Only exposures to counterparties for which
the bank has supervisory approval for modelling the specific risk of debt
instruments are to be included into the advanced CVA risk charge.

50.10 The CVA risk capital requirement consists of both general and specific credit
spread risks, including stressed VaR but excluding the incremental risk capital
requirement. The VaR figure should be determined in accordance with the
quantitative standards described in MAR30.12 to MAR30.15. It is thus determined
as the sum of the non-stressed VaR component and the stressed VaR
component. For the calculation of each component:

(1) When calculating the non-stressed VaR, current parameter calibrations for
expected exposure must be used.

(2) When calculating the stressed VaR future counterparty EE profiles (according
to the stressed exposure parameter calibrations as defined in CRE53.51) must
be used. The period of stress for the credit spread parameters should be the
most severe one-year stress period contained within the three-year stress
period used for the exposure parameters.1

Footnotes
1 Note that the three-times multiplier inherent in the calculation of a
bond VaR and a stressed VaR will apply to these calculations.

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 FAQ
FAQ1 MAR50.10 requires a period of stress for credit spread parameters to be
used in determining future counterparty EE profiles under the stressed
VaR capital component of the advanced CVA risk capital requirement.
We seek confirmation that the credit spread of the counterparty input
into the CVA and regulatory CS01 formulae (ie si) is not impacted by
this. That is, the si inputs remain the same for both the VaR and
stressed VaR capital calculations of the CVA risk capital requirement.

It depends on the specific risk VaR model. If the VaR model uses a
sensitivity (or Greek) based approach, the credit spread values in the
1st and 2nd-order sensitivities (as in MAR50.7) are the current levels
(“as of valuation date”) for both unstressed VaR and stressed VaR. In
contrast, if the VaR model uses a full-revaluation approach using the
CVA formula as in MAR50.3, the credit spread inputs should be based
on the relevant stress scenarios.

FAQ2 Does a specific backtesting on the CVA VaR need to be conducted or is

the backtesting of the market VaR considered as relevant also for the
CVA VaR? In particular, MAR50 (footnote 1) says that “the three-times
multiplier inherent in the calculation of a bond VaR and a stressed VaR
will apply to these calculations.” Does it mean that the multipliers
applied to the CVA VaR have to be the same as the multipliers applied
to the market risk VaR (ie at least 3 + backtesting of market risk VaR)
or does a specific multiplier for the CVA capital requirement need to be
calculated depending on the results of the backtesting of the CVA VaR?

Banks are not required to conduct a separate VaR backtesting for

purposes of the CVA capital requirement. MAR50 (Footnote 1) was
intended to require banks to apply at least a three-times multiplier and
a potentially higher multiplier for CVA purposes where appropriate.

FAQ3 From MAR50.10, our understanding is that the periods involved in the
calculation of stressed Effective expected positive exposure (EPE) and
the CVA capital requirement, according to MAR50.10(2), are as follows:

A period of stress to the credit default spreads of a bank’s

counterparties. The length of this period is not defined (in CRE53.
51);
A three-year period containing period (1). This three-year period
is used for calibration when calculating stressed Effective EPE; 
The one-year period of most severe stress to credit spreads within
period (2). This one-year period is used when calculating stressed
VaR, as described in MAR50.10(2). In general, period (3) will be

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 different from the one-year period used to calculate stressed VaR,
as described in MAR30.14 to MAR30.17. The difference is due to
period (3) being a period of stress to credit spreads, whereas the
market risk one-year period is a period of stress to the bank’s
portfolio and therefore to all types of market risk factor that
affect the portfolio.

Please confirm our understanding of the above.

Yes, this is correct. The one-year period of stress used for the stressed
CVA VaR calculation is the most severe year within the three-year
period used for the stressed Effective EPE calculation. This one-year
period may, and will probably, be different to the one-year period used
for market risk calculations.

50.11 This additional CVA risk capital requirement is the standalone market risk charge,
calculated on the set of CVAs (as specified in MAR50.3) for all OTC derivatives
counterparties, collateralised and uncollateralised, together with eligible CVA
hedges. Within this standalone CVA risk capital requirement, no offset against
other instruments on the bank’s balance sheet will be permitted (except as
otherwise expressly provided herein).

FAQ
FAQ1 A strict interpretation of MAR50.12 and MAR50.13 suggests that
market LGDs (based on bond recovery rates) should be used instead of
LGDs that reflect internal experience, potential security packages or
other credit enhancement that could be available in the Credit Support
Annex or the trade confirmation. Is this strict interpretation intended by
the Committee?

Yes, market LGDs (LGDMKT) based on market recovery rates are used
as inputs into the CVA risk capital requirement calculation. LGDMKT is
a market assessment of LGD that is used for pricing the CVA, which
might be different from the LGD that is internally determined for the
IRB and CCR default risk charge. In other words, LGDMKT needs to be
consistent with the derivation of the hazard rates – and therefore must
reflect market expectations of recovery rather than mitigants or
experience specific to the bank.

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50.12 Only hedges used for the purpose of mitigating CVA risk, and managed as such,
are eligible to be included in the VaR model used to calculate the above CVA

capital requirement or in the standardised CVA risk capital requirement set forth
in MAR50.15 and MAR50.16. For example, if a CDS referencing an issuer is in the
bank’s inventory and that issuer also happens to be an OTC counterparty but the
CDS is not managed as a hedge of CVA, then such a CDS is not eligible to offset
the CVA within the standalone VaR calculation of the CVA risk capital
requirement.

FAQ
FAQ1 We seek clarity on the treatment of internal trades and CVA VaR.
There is a concern that if a CVA desk buys protection from another
desk (within the bank) which faces ”the street” it would not get CVA
credit although the CVA VAR would be flat (MAR50.12).

Only hedges that are with external counterparties are eligible to reduce
CVA. A hedge that is only with an internal desk cannot be used to
reduce CVA.

50.13 The only eligible hedges that can be included in the calculation of the CVA risk
capital requirement under MAR50.3 or MAR50.15 and MAR50.16 are single-name
CDSs, single-name contingent CDSs, other equivalent hedging instruments
referencing the counterparty directly, and index CDSs. In case of index CDSs, the
following restrictions apply:

(1) The basis between any individual counterparty spread and the spreads of
index CDS hedges must be reflected in the VaR. This requirement also
applies to cases where a proxy is used for the spread of a counterparty, since
idiosyncratic basis still needs to be reflected in such situations. For all
counterparties with no available spread, the bank must use reasonable basis
time series out of a representative bucket of similar names for which a
spread is available.

(2) If the basis is not reflected to the satisfaction of the supervisor, then the
bank must reflect only 50% of the notional amount of index hedges in the
VaR.

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 FAQ
FAQ1 With regard to MAR50.3: we seek confirmation as to whether the risk
mitigation available for EE profiles remains unchanged. Specifically,
please confirm our understanding that the post risk mitigated exposure
values are used in the CVA capital requirement, whilst the additional
mitigation is also allowed for the CVA capital requirement itself, via
eligible CVA hedges, which is undertaken post any EE mitigation
available.

The EEs or the EADs used as inputs in the advanced and standardised
CVA risk capital requirement must not have been subject to any
adjustments arising from credit protection that a firm intends to
include as an eligible hedge in the CVA risk capital requirement (see
MAR50.12 to MAR50.14). However, the use of other types of credit risk
mitigation (eg collateral and/or netting) reducing the EE or the EAD
amounts in the CCR framework can be maintained when these EE or
EAD feed the CVA risk capital requirement.

FAQ2 Industry seeks clarification as to whether (i) CDS swaptions are eligible
CVA hedge instruments; and if so, (ii) whether both single name and
index CDS swaptions are eligible.

A CDS swaption can be considered as an equivalent hedging

instrument, and therefore CDS swaptions are eligible hedge
instruments, in both single-name and index CDS cases, insofar as the
contract does not contain a knock-out clause, ie the option contract is
not terminated following a credit event. As per banks applying the
advanced CVA risk capital requirement (see MAR50.3 to MAR50.14),
their VaR model should properly capture the non-linear risk of
swaptions. As regards banks that use the standardised CVA approach,
they may apply the delta-adjusted notional to reflect the moneyness of
the option into the standardised CVA formula.

FAQ3 Industry seeks further clarifications as to how the following two cases
of different risk characteristics associated with CVA hedge providers
should be treated for CVA capital requirement purposes. Is a single
name CDS (or a basket of CDS that is not tranched) an eligible CVA
hedge if the entity that provides protection is any kind of special
purpose entity (SPE), private equity fund, pension fund, or any other
non-bank financial entity? Does the answer change if the bank is
providing a liquidity facility or another kind of credit enhancement to
the protection provider, whereby the bank is effectively exposed to a
certain tranche of the underlying default risk? (That is, a bank buys
CDS protection, while an additional transaction or facility is
transferring a tranche of the default risk back to the bank.) The

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 liquidity facility or credit enhancement would be on accrual accounting
so that no CVA risk is transferred back to the bank via that facility.

There are no specific restrictions on the protection provider for the

purposes of the CVA hedges. Eligible CVA hedges can be bought from
SPEs, private equity funds, pension funds, or other non-bank financial
entities as long as the general eligibility criteria set by the Basel
framework (see in particular CRE22.90) are met. If the bank remains
effectively exposed to a tranche of the underlying default risk by
providing any form of credit enhancement to the protection provider,
then the CDS is not an eligible CVA hedge because, in economic
substance, the transaction becomes a tranched CDS protection,
regardless of whether the credit enhancement is on accrual accounting.
All kinds of engagement between the bank and the protection provider
need to be taken into account in order to determine whether the
protection is effectively tranched.

FAQ4 What are the eligible hedges for the CVA volatility charge when a
transaction has securitisations as underlying and the firm is not
allowed to use a VaR model to calculate market risk capital for
securitisations?

While it is true that banks are not allowed to use a specific risk VaR
model for securitised products, this is not applicable for CVA capital
requirement purposes. Different product types of derivatives (including
securitised products) form expected exposures underpinning CVA to a
certain counterparty, whereas the eligible hedge instruments apply to
those credit hedges referencing a bank’s counterparties (via either
single-name or index). The supervisory approval of the market risk VaR
model for advanced CVA risk capital requirement purposes should
apply to specific interest risk VaR, ie a VaR model for debt instruments.
This VaR can be used to reflect the risk of credit spread changes for
single-name CDS products, including those referencing debt
instruments issued by the counterparty. Hence, banks should not
encounter any issues of calculating the advanced CVA even if the
regulatory approval for specific risk VaR model for securitised products
is not available.

FAQ5 When hedging CVA, given the underlying derivatives portfolio (netting
sets) is changing over time, excess CDS hedges bought cannot always
be unwound and are sometimes “cancelled” by selling protection (ie
the CVA desk is selling protection). The eligible CVA over-hedge is the
hedge to this protection sold. How is this to be recognised under Basel
III?

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 Since the dedication of CDS-bought protection for the purpose of CVA
hedging needs to be done explicitly, the same process, documentation
and controls can be and are expected to be applied for bought
protection as well by partial unwinding the excess CDS hedges by
making use of the same instrument via the opposite position; this
being based on approval of the national supervisor.

If the national supervisor does not agree to recognise the inclusion of

sold protection in the framework (standalone portfolio) of CVA
calculation and CVA hedging, respective trades are treated as any
other derivative or any CDS that is not part of CVA hedging.

FAQ6 From MAR50.13, we would like clarification in terms of eligibility of

hedges. Is a CDS indirectly referencing a counterparty (eg a related
entity) an eligible hedge? Can you confirm inclusion of sovereigns in
the CVA capital requirement and ability to use sovereign CDS as
hedges?

Any instrument of which the associated payment depends on cross

default (such as a related entity hedged with a reference entity CDS
and CDS triggers) is not considered as an eligible hedge. When
restructuring is not included as a credit event in the CDS contract, for
the purposes of calculating the advanced CVA capital requirement, the
CDS will be recognised as in the market risk framework for VaR. For
the purposes of the Standardised CVA capital requirement, the
recognition of the CDS hedge will be done according to the
standardised measurement method in the market risk framework. The
Committee confirms that sovereigns are included in the CVA capital
requirement, and sovereign CDS is recognised as an eligible hedge.

FAQ7 Industry seeks further clarification as to whether a single-name CDS for

which the bank uses proxies can also be considered as eligible hedges.
The answer to MAR50.13(FAQ6) states: “Any instrument of which the
associated payment depends on cross default (such as a related entity
hedged with a reference entity CDS and CDS triggers) is not considered
as an eligible hedge.” A question has arisen whether this means that a
single-name CDS cannot be recognised against an exposure to a
related counterparty (for example a sovereign CDS against a province
in the same country) even if the VaR model captures the basis risk
between the exposure and the hedge, or was this clause aimed at
instruments other than single-name CDS, that pay out only if there is
more than one default event.

Single -ame proxy hedges cannot be recognised in the advanced CVA

capital requirement, irrespective of whether the basis risk between the

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 exposure and the hedge is appropriately captured in the model. In fact,
MAR50.13 admits as eligible hedges only instruments (such as CDSs
and contingent CDSs) referencing the counterparty directly or index
CDSs. As an example, consider an exposure to counterparty B with no
CDS traded on its name (eg a province within a country) whose spread
is approximated by that of counterparty A (eg the central government
of that country). The only eligible hedge of the exposure to
counterparty B would be an index C containing counterparty A,
provided the bank can incorporate the basis between C and A into its
VaR model to the satisfaction of its supervisor.

Further, to the extent that single-name proxy hedges are not to be

recognised in the advanced CVA capital requirement on one hand, but
a proxy spread is required to be used whenever the relevant CDS
spread is not available on the other hand, banks should be further
noted that they are prohibited from, or should derecognise, over
hedging on a single-name level.

To illustrate this, in the above example, whenever the bank over

hedges its exposure to A, these hedges on A will effectively act as a
proxy hedge for the exposure to B; this is true irrespective of whether B
is mapped to the CDS spread of A or not. Therefore, the firm should set
a cap on the recognition of all single-name hedges.

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50.14 Other types of counterparty risk hedges (ie those not listed in MAR50.13) must
not be reflected within the calculation of the CVA capital requirement, and these
other hedges must be treated as any other instrument in the bank’s inventory for
regulatory capital purposes. Tranched or nth-to-default CDSs are not eligible CVA
hedges. Eligible hedges that are included in the CVA capital requirement must be
removed from the bank’s market risk capital requirement calculation.

FAQ
FAQ1 With respect to identifying eligible hedges to the CVA risk capital
requirement, the Basel III provisions state that “tranched or nth-to-
default CDSs are not eligible CVA hedges” (MAR50.14). Can the Basel
Committee confirm that this does not refer to tranched CDS
referencing a bank’s actual counterparty exposures and refers only to
tranched index CDS hedges? Also, can the Committee clarify that Risk
Protection Agreements, credit-linked notes, short bond positions as
CVA hedges, and First Loss on single or baskets of entities can be
included as eligible hedges?

All tranched or nth-to-default CDS are not eligible. In particular, credit-

linked notes and first loss are also not eligible. Single name short bond
positions may be eligible hedges if the basis risk is captured. When
further clarifications are needed, banks should consult with supervisors.

Standardised CVA risk capital requirement

50.15 When a bank does not have the required approvals to use MAR50.3 to calculate a
CVA capital requirement for its counterparties, the bank must calculate a portfolio
capital requirement using the following formula, where:

(1) h is the one-year risk horizon (in units of a year), h = 1.

(2) wi is the weight applicable to counterparty i. Counterparty i must be mapped

to one of the seven weights wi based on its external rating, as shown in the
table below. When a counterparty does not have an external rating, the bank
must, subject to supervisory approval, map the internal rating of the
counterparty to one of the external ratings.

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 (3) is the EAD of counterparty i (summed across its netting sets),
including the effect of collateral as per the existing IMM or SA-CCR rules as
applicable to the calculation of counterparty risk capital requirements for
such counterparty by the bank. For non-IMM banks the exposure should be

discounted by applying the factor . For IMM banks, no such

discount should be applied as the discount factor is already included in Mi.

(4) Bi is the notional of purchased single-name CDS hedges (summed if more

than one position) referencing counterparty i, and used to hedge CVA risk.
This notional amount should be discounted by applying the factor

(5) Bind is the full notional of one or more index CDS of purchased protection,
used to hedge CVA risk. This notional amount should be discounted by

applying the factor

(6) wind is the weight applicable to index hedges. The bank must map indices to
one of the seven weights wi based on the average spread of index ‘ind’.

(7) Mi is the effective maturity of the transactions with counterparty ‘i’. For IMM-
banks, Mi is to be calculated as per CRE53.20. For non-IMM banks, Mi is the
notional weighted average maturity as referred to in CRE32.44. However, for
this purpose, Mi should not be capped at 5 years.

(8) Mihedge is the maturity of the hedge instrument with notional Bi (the
quantities MihedgexBi are to be summed if these are several positions).

(9) Mind is the maturity of the index hedge ”ind”. In case of more than one index
hedge position, it is the notional weighted average maturity.

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 (10) For any counterparty that is also a constituent of an index on which a CDS
is used for hedging CCR, the notional amount attributable to that single
name (as per its reference entity weight) may, with supervisory approval, be
subtracted from the index CDS notional amount and treated as a single

name hedge (Bi) of the individual counterparty with maturity based on the
maturity of the index.

FAQ
FAQ1 MAR50.15 states that, in the case of index CDSs, the following
restrictions apply: “Mi is the effective maturity of the transactions with
counterparty i. For IMM banks, Mi is to be calculated as per CRE53.20.
For non-IMM banks, Mi is the notional weighted average maturity as
referred to in CRE32.44”. CRE32.41 includes in it a cap which means
that M will not be greater than 5 years. Can the Basel Committee
provide clarity on whether this cap still applies for the purpose of
calculating Mi above?

For CVA purposes, the 5-year cap of the effective maturity will not be
applied. This applies to all transactions with the counterparty, not only
to index CDSs. Maturity will be capped at the longest contractual
remaining maturity in the netting set.

FAQ2 MAR50.15(7) talks about effective maturity at a counterparty level. In

rolling up effective maturity from netting sets to counterparty, do we
apply the one-year floor first and then do a weighted average by
notional, or do we calculate the weighted average by notional at
counterparty level and then apply the floor?

The 1-year floor applies at a netting set level. If there is more than one
netting set to the same counterparty, an effective maturity (M) should
be determined separately for each netting set, the EAD of each netting
set should be discounted according to its individual maturity and the
quantities M x EAD should be summed.

FAQ3 If a bank has more than one CDS contract on the same counterparty,
the instructions for the standardised CVA capital requirement demand

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 a different discounting than in the case of several index CDS. For single-
name CDS, each contract gets discounted using its individual maturity
and the quantities M x B are to be summed. In contrast, for index-CDS,
the full notional (summed over all index contracts) must be discounted
using the average maturity. Is there a reason for this difference in the
treatment of single-name vs index hedges?

For index CDS, the same treatment should be applied as described for
single-name CDS. That is, each index contract gets discounted using its
individual maturity and the quantities M x B are to be added.

FAQ4 In the standardised CVA capital requirement formula, there are

“weights” for individual counterparties (wi) and for credit indexes (wind
). “Weights” wi are uniquely determined by the counterparty’s rating
from the table in MAR50.15. How should one determine “weights” wind?

Banks should first look through index constituents’ ratings so as to

determine the corresponding weight for each constituent, which then
should be weight-averaged for determining the weight for the index.

50.16 The weights referenced in MAR50.15 above are set out in the following table, and
are based on the external rating of the counterparty:2

Rating Weight wi

AAA 0.7%

AA 0.7%

A 0.8%

BBB 1.0%

BB 2.0%

B 3.0%

CCC 10.0%

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 Footnotes
2 The notations follow the methodology used by one institution,
Standard & Poor’s. The use of Standard & Poor’s credit ratings is an
example only; those of some other approved external credit assessment
institutions could be used on an equivalent basis. The ratings used
throughout this document, therefore, do not express any preferences or
determinations on external assessment institutions by the Committee.

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