The standardized approach to counterparty default risk in CRR II

Counterparty default risks with SA-CCR

First described in 1988 (bcbs04), the market valuation method for calculating risk exposure values for derivatives will become a thing of the past with the implementation of the new standard method "Standardized Approach for Counterparty Credit Risk" (SA-CCR). At the EU level, the method developed by the Basel Committee was incorporated into CRR II, which was published on 7 June 2019.

Using the new standardized methods starting 28 June 2021

The new standardized approach to counterparty risk default is to replace the market valuation method as well as the previous standard method. Only banks with a smaller derivatives portfolio have the option of using one of the simplified methods (the simplified SA-CCR or revised original risk method). The new requirements for calculating counterparty default risk apply from 28 June 2021.

In all three methods, the risk exposure value is calculated as the sum of the replacement cost (RC) and potential future exposure (PFE) - a premium to take future market value fluctuations into account. A new factor, alpha (= 1.4), which is specified by the regulatory authority, must be used to scale the risk position value.

More risk-sensitive analysis of netting and hedging effects with SA-CCR

The risk position value is calculated at the level of a netting rate. Assigning transactions to a netting agreement recognized by the regulatory authorities provides the basis for generating netting records.
Replacement cost (RC) is calculated using the SA-CCR method, taking into account the collateral received and provided. Existing margin agreements mitigate risk and are therefore one of the possible levers for keeping the expected negative, quantitative SA-CCR effects to a minimum.

Newly designed and significantly more risk-compatible than in the market valuation method is the calculation of the premium (add-on). The new standard takes the hedging and netting effects of offsetting derivatives into account. The transactions must be assigned defined hedging rates for each risk category (interest rate, foreign currency, loan, share price, commodity position and other risks). Risk positions of individual derivatives within the hedging rates are aggregated with newly calibrated supervisory and correlation factors specified by the regulatory authorities. A new component of the potential future risk position (PFE) is the multiplier, which reduces the netting rate in the event of overcollateralization or negative market values.

Have a look at our chart to get a better idea of the components of the SA-CCR calculation:

SA-CCR calculation sizes

Explicit requirements for items still under discussion

The EBA is to set out requirements for the following points that are still open in CRR II in an RTS to be submitted to the EU Commission by 28 December 2019: 

  • Assigning products to one or more risk categories,
  • Delta calculations for optional interest derivatives (determining the lambda shift),
  • Defining the direction of the transaction according to the main risk driver.

A consultation paper (EBA/CP/2018/03) about this was published on 5 February 2019.

The new standardized approach: what are the challenges?

Banks are faced with three major challenges when it comes to implementing the new standardized approaches:
-    Determining where in the bank the SA-CCR ratios are to be calculated;
-    New, significantly larger data requirements;
-    Assessing the impact of the change in methods.
You’ll find more information about these challenges here.

What we recommend

Use the time until the implementation date, 28.06.2021, to weigh all your SA-CCR options, plan implementation projects well in advance and, with the help of trial calculations, take action early if necessary to minimize any adverse effects. You can count on SKS to guide you through the process.

From as early as 2013, we have been supporting our clients analyze the impacts of new requirements from the regulatory authorities on this issues, both technically and in terms of its implications for your IT. As one of the first consulting firms involved in this area, we developed a mass data-capable, Excel-based calculation tool that makes the increased data requirements transparent. Our tool enables us to work with customers to create holistic calculations of risk exposure values according to SA-CCR for their institution’s particular portfolio.
SKS is a name you can trust for your SA-CCR preliminary study as well as for any corresponding implementation projects. In addition to our expertise in terms of the technical requirements, you stand to benefit from our practical experience gained from implementing the new standard procedure for other clients.

Also be sure to take advantage of our seminar and webinar modules on this topic.