XVA metrics for CCP optimization

Abstract

Based on an XVA analysis of centrally cleared derivative portfolios, we consider two capital and funding issues pertaining to the efficiency of the design of central counterparties (CCPs). First, we consider an organization of a clearing framework, whereby a CCP would also play the role of a centralized XVA calculator and management center. The default fund contributions would become pure capital at risk of the clearing members, remunerated as such at some hurdle rate, i.e. return-on-equity. Moreover, we challenge the current default fund Cover 2 EMIR sizing rule with a broader risk based approach, relying on a suitable notion of economic capital of a CCP. Second, we compare the margin valuation adjustments (MVAs) resulting from two different initial margin raising strategies. The first one is unsecured borrowing by the clearing member. As an alternative, the clearing member delegates the posting of its initial margin to a so-called specialist lender, which, in case of default of the clearing member, receives back from the CCP the portion of IM unused to cover losses. The alternative strategy results in a significant MVA compression. A numerical case study shows that the volatility swings of the IM funding expenses can even be the main contributor to an economic capital based default fund of a CCP. This is an illustration of the transfer of counterparty risk into liquidity risk triggered by extensive collateralization.

Systemic Risk Models for Disjoint and Overlapping Groups with Equilibrium Strategies

“…Different sets of strategies may generate the same groups denoted by C(a). We say two strategies a (1) and a (2) are equivalent, if the partitions C(a (1) ) and C(a (2) ) are equivalent. With the individual systemic risk allocation in (2.5), the objective function of individual n under the partition C(a) is defined by…”

“…In the following, we present three concrete examples to help better understand on banks' rational choices under this fair risk allocation. 1), and the utility parameters are identical, denoted by α(> 0). Then there is only one trivial Nash equilibrium, that is, all individuals being in the same group.…”

“…Meanwhile, central clearing counterparties (CCPs) are introduced to the financial markets to mitigate the cascade defaults. They require default funds from their members to absorb the cost of clearing member's defauls, and several mechanisms of default funds have been designed [1].…”

Positive XVAs

“…This is done in an abstract setup, which is then specified to bilateral and centrally cleared trading setups. Related numerics are provided in Albanese, Crépey, Hoskinson, and Saadeddine [7] and Abbas-Turki, Crépey, and Saadeddine [1] for the bilateral trading case and in Albanese, Armenti, and Crépey [4] for the centrally cleared case.…”

“…All the processes in the paper are G adapted and all the random times of interest are G stopping times. The probability measure Q is used for the linear valuation of cash flows 3 , using the risk-free asset as our numéraire everywhere 4 . The XVA matter also crucially entails nontraded assets (or trading constraints).…”