MAR50 With Faq
MAR50 With Faq
MAR50 With Faq
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.
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:
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.
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.
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.
(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.
(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.
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.
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.
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))]?
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.
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.
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.
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:
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.
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.
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.
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
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?
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?
(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
(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.
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.
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
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.
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%