Accounting regulations and Basel III have put Credit Value Adjustment (CVA) firmly in the spotlight. Basel III mandates the calculation of an additional CVA capital charge for OTC positions. This will have a direct impact on the profitability of existing OTC business lines within many organizations, from global banks through to regional franchise banks.
Will central clearing and the trend for increased collateralization negate the need for CVA management? Without a doubt it will have an impact, but neither collateral agreements nor CCPs completely eliminate credit risk. And commercial banks will always have a significant business in OTC derivatives with corporate customers with little or no exposure mitigation. The need for CVA is here to stay. In fact, the emergence of the CVA desk has been one of the noteworthy trends in the front office over the last few years.
This is forcing institutions to look ever more closely at CVA. Traders now have to factor in the cost of credit risk when making trading decisions, and CVA needs to be a key part of the daily workflow.
Calculating CVA allows you to be aggressive in your pricing of certain transactions while understanding where the CVA makes a new transaction uneconomic at a price. Using CVA effectively also helps you improve counterparty selection and manage and hedge the credit risk on your books.