Valuation of IR Derivatives in a new
Regulatory Environment
Speakers:
Eduardo Pereira
Bernardo Santos Andrade
Dutch Association of Corporate Treasurers Event:
Risk and Regulation Specialist: Bloomberg L.P
Senior Manager, Toyota Motor Finance (Netherlands) B.V
Hotels Van Oranje, Noordwijk, The Netherlands.
11th November 2013.
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•
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OIS Discounting: A new valuation framework;
CSA Agreements;
CVA;
CSA Agreements – Bloomberg ‘MARS’ solution;
TMFNL: Collateral Operation Case Study.
Agenda
OIS Discounting
• Prior to Credit Crisis credit & liquidity effects were
largely ignored in IR derivatives pricing
• Subsequent to Credit Crisis
– Stronger Focus on Counterparty Risk (Credit)
• Evaluating Exposure
• Risk Management
– Stronger Focus on Funding (Liquidity)
• Divergence between “risk free” rates and funding levels
• Funding arbitrage opportunities
• New framework required as credit & liquidity
effects can no longer be ignored in pricing
Overview of OIS Framework
Swap Value
1,000,000
Market Value in EUR
800,000
600,000
400,000
200,000
0
21-Oct-05
21-Oct-06
21-Oct-07
21-Oct-08
21-Oct-09
21-Oct-10
(200,000)
(400,000)
(600,000)
26th Oct 2005: 10MM EUR 7yr Pay 3.10%, q/q
• IR swaps can have both negative or positive
values
• If market value is positive
 Counterparty owes money
And if counterparty defaults
 Loss for everything that can’t be recovered........
• Credit mitigation very important
• Changes in Regulation
Banks to be penalised for uncollateralised swaps
Counterparty Risk
• Mitigating credit exposure (interbank)
– Netting Agreements
– Credit Support Annex (CSA) agreement
– Central Counterparty (CCP) clearing
• CSA: Collateral posted between counterparties
• CCP (e.g. LCH.Clearnet): “Variation Margin”
paid (or received) each day by clearing
member (in addition to “Initial margin”)
• Both CSAs & CCP define how interest accrues
on funds (collateral or margin payments)
Swaps in the Interbank Market
Credit & Liquidity Premium in Euribor
LOIS EUR <GO>
Credit & Liquidity Premium in Euribor
Credit Crunch: Market First Fears
Credit & Liquidity Premium in Euribor
Bear Stearns ‘Bailout’
Credit & Liquidity Premium in Euribor
Lehman Bankruptcy
Credit & Liquidity Premium in Euribor
Ireland Crisis
• IR swaps can have both negative or positive values
• If market value is positive
 Counterparty owes money
And if counterparty defaults
 Loss for everything that can’t be recovered........
• Credit mitigation very important
• Banks generally have agreements to post collateral to
each other
– Credit Support Annex (CSA) agreement
– Central Counterparty Clearing (CCC)
• Generally corporates do not wish to sign CSAs or agree
to CCCs
 Both parties exposed to counterparty risk
Counterparty Risk
Counterparty Valuation Adjustments
For a swap how do you currently determine
what you are being charged for your credit
risk?
• By using the Bloomberg CVA/DVA calculator
• My relationship banks provide full disclosure
on these charges
• Unaware of any such charges
• We calculate using other methods
• We do not get charged
Webinar Poll 2 - Question
Responses: 106
5%
16%
23%
Bloomberg Calculator
Full disclosure
33%
Unaware
Other Methods
23%
Not charged
Webinar Poll 2 Results
Calculating Credit Spreads
CVA/DVA Calculator
Calculating Credit Spreads
Calculate Exposure from Counterparties Perspective
Calculating Credit Spreads
Market Information: Credit, Rates & Volatility
Calculating Credit Spreads
DVA: Cost to Bank of Corporate Defaulting
Calculating Credit Spreads
CVA Calculation: Cost to Corporate of Bank Defaulting
Calculating Credit Spreads
Bilateral Calculation
Exposure Graph
Bilateral Calculation
Charting Net Cash Flows
Net Cash Flows affect Exposures