Valuation of IR Derivatives in a new Regulatory Environment Speakers: Eduardo Pereira Risk and Regulation Specialist: Bloomberg L.P Bernardo Santos Andrade Senior Manager, Toyota Motor Finance (Netherlands) B.V Dutch Association of Corporate Treasurers Event: Hotels Van Oranje, Noordwijk, The Netherlands. 11 th November 2013.
Agenda OIS Discounting: A new valuation framework; CSA Agreements; CVA; CSA Agreements – Bloomberg MARS solution; TMFNL: Collateral Operation Case Study.
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
26 th 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 cant 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
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 cant 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
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