Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

18.1 Introduction

In this chapter, we deal with the management of counterparty risk within a financial institution. Whilst some large dealers have utilised “CVA desks”¹ for many years to manage counterparty risk, this practice has spread to other banks only more recently because of the global financial crisis. The move to fair value accounting requires financial contracts such as OTC derivatives to have an adjustment applied to reflect the possibility of counterparty default. Whilst many institutions view CVA as purely an accounting need, it has become increasingly common for banks to charge for the expected loss of their credit risk (CVA). Furthermore, the Basel III regulatory changes are likely to catalyse all banks to have a CVA desk responsible for the pricing and management of CVA and the optimisation of regulatory capital. However, other peripheral components exist that may be centralised alongside CVA aspects. These include collateral management (Chapter 5) and funding aspects (Chapter 14).

It is not only banks that need CVA functions of some sort. Other large financial institutions, and/or significant OTC derivatives users, may deem it necessary to have centralised functions to manage their counterparty risk. Depending on the risk management sophistication of a particular institution and the overall amount of counterparty risk, the management approach will differ.

A CVA desk can add significant value to an institution's risk management. They can allow the firm to be competitive ...