Adapting to SA‑CCR: Managing the increased cost of derivatives trading

The Basel Committee on Banking Supervision’s standardised approach to counterparty credit risk (SA‑CCR) framework is already under way. The new formula for calculating derivatives exposures was implemented in June 2021 in the European Union and kicked off in January 2022 in the UK and US as part of the Capital Requirements Regulation (CRR II) package of reforms.

Backstop measures such as the Collins floor mean SA‑CCR is a very important metric for banks’ capital footprints. It is already having a disparate impact on banks and creating winners and losers, with different businesses having a rise or a decrease in risk-weighted assets.   

European banks are being offered temporary relief to lower the impact of SA‑CCR as part of CRR III, but there has been infighting in Europe over these transitional rules. As financial institutions continue to contemplate the collapse of Archegos, doubts loom over the usefulness of these standardised models for risk-managing single counterparties or portfolios.

In any case, SA‑CCR punishes uncollateralised swaps and directional risk, which make up a large proportion of the foreign exchange swaps and forwards market. This has prompted widening spreads for these products, as seen in the case of Citi. So, after a decade of tight spreads, the market is expected to widen for FX forwards and swaps. This has led to demand for next-generation rebalancing tools as banks prioritise optimisation of these assets. Erik Petri’s article in this report offers a timely discussion of the nuances of over-the-counter credit risk management, and opportunities for firms to manage and optimise counterparty credit risk (CCR).

The banks certainly have some criticism of SA‑CCR, and are still not convinced that the switch from internal ratings-based models to standardised risk weights has been beneficial. SA‑CCR was conceived 15 years ago, so some conservative elements – such as the alpha factor – were devised in a different time. Banks point out that they now have better data and faster technology, allowing them to use internal models for a more risk-sensitive view than the standardised approach can offer. But they are stuck with SA‑CCR for now – and the choice is not between internal models and SA‑CCR. Regulators have replaced the old, standardised approach – the current exposure method (CEM) – with this new one. While it may be too conservative, there is consensus that it is far more risk-sensitive than CEM, which is a very crude method for tallying up exposures. Industry experts discuss these issues and how banks are adapting to the new regime in a roundtable Q&A in this report.

The increased cost of trading FX forwards and swaps will most likely result in banks changing how they price certain trades. Some products may become prohibitively expensive, which could prompt banks to change their business models. They might target different types of clients that have less directionality in their trades and more balanced portfolios. But experts agree they are likely to make these changes incrementally over several years, rather than upsetting clients with dramatic price changes from one year to the next.

 

Counterparty credit risk: special report 2022
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