XVA in Japan: outlook for 2022

Adoption of Credit Valuation Accounting Adjustment (CVA) began in April 2021 amid economic disarray and the application of various financial restrictions due to the Covid-19 pandemic. Financial institutions are now accelerating their adoption measures while carefully studying the status of their global competitors.

With this in mind, this article offers an overview of the current state of valuation adjustments – collectively known as XVA – as well as a perspective on valuation management, based on the article Latest trends regarding valuation in Japan, which was discussed during the 2021 Risk Session of the Japan XVA panel held in September 2021.

Recent Developments in Accounting CVA in Japan

First, let’s describe the current situation of CVA in Japan. In preparation for the adoption of XVA, megabanks have sought ways to obtain the information needed to calculate XVA: that is, by capturing a variety of market consensus data and establishing a simplified process for Systematically capture counterparty credit information, transaction data and market data, including credit default swaps (CDS). IHS Markit has had several instances where its data has been used in this way.

Banks need to manage XVA risk with accurate and efficient hedging operations. The pandemic, followed by a rapid economic downturn, quickly reduced liquidity in the 2020 CDS market. The turmoil was so intense that iTraxx Japan recorded a peak in the CDS basis exceeding 180. This high level of volatility in the market has made more significant hedging operations necessary and reiterated the importance of XVA risk management. During this period, a bank used iTraxx EUR instead of iTraxx Japan to hedge the volatility of Japanese credit spreads, given the liquidity. This is a good example of how operating XVA requires an innovative and data-driven strategy.

This fiscal year, IHS Markit has had dozens of accounting CVA adoptions at other institutions, including regional and national banks. However, the establishment of a dedicated department at XVA, whose function includes hedging – as is the case in megabanks – remains rare. Most believe that the CVA/debit valuation adjustment (DVA) amounts of their companies do not justify the effort and resources required for management by a dedicated desk.

That said, accounting CVA is critical because of its impact of fair value measurement on derivative assets and liabilities on balance sheets. Without information based on consensus market data, it becomes more difficult to produce an accurate balance sheet in accordance with the requirement of the “exit price” accounting standard. Additionally, some level of risk management framework is required for fluctuating CVA/DVA numbers. The adoption of CVA improves the management of counterparty risk, which is why it is not only part of an accounting discussion, but also extends to risk management.

SA‑CVA or BA‑CVA?

The next challenge for banks that have adopted accounting CVA is the assessment of CVA risk assets in Basel III. Choosing between the Standard CVA Approach (SA-CVA) and the Basic CVA Approach (BA-CVA) can be an important turning point in a general hedging strategy.

SA‑CVA is a method for significantly reducing risk-weighted assets (RWA). Its effectiveness has also been established in terms of hedging against credit risk, as well as against interest rate and exchange rate risks. By setting up an XVA desk as part of a hedging strategy, financial institutions opting for SA‑CVA can expect a positive impact on the management of their RWA.

Some believe that the BA-CVA – which is considered an upgrade to the current standard formula for measuring risk – may lead to higher capital requirements compared to the current standard formula. But others are of the view that BA-CVA is easy to adopt, as system developments can remain on a limited scale. Either way, studying the strength of your bank’s derivatives portfolio and strategy, before deciding what to do and how far to go, is the next logical step in maintaining a stable computing system. It is undeniable that this end goal is of the utmost importance.

IHS Markit Perspectives on XVA Management: Towards Stabilized Risk Management

As noted earlier, institutions that have already adopted CVA will likely proceed to organize data and improve simulations. In a recent market chat, a company late in its XVA journey said, “If our funding curves and our lending curves are the same, we’re basically giving traders the choice. We’re debating so where we should define our funding curve.” Examples like this demonstrate why we believe there remains a high level of interest in more XVA. IHS Markit has also discussed with many banks the funding of XVA as a counterparty valuation function against the market value discount parameter for transactions.

With regard to market value adjustment, capital value adjustment (KVA) and their usefulness in hedging transactions, we anticipate a growing interest in new datasets (historical data, e.g. ). In addition, the collection and use of this data could require an overhaul of computer systems. The 2021 Risk Japan XVA Roundtable discussed the challenge of maintaining human and technological resources around XVA computing even in large banks.

Previously, we have often heard that cloud services pose a security risk. However, as banks are increasingly called upon to improve their derivatives pricing and portfolio management, many institutions told us that, given the difficulty of managing transactions internally, they naturally consider to use cloud services.

It seems that adopting CVA comes with all sorts of organizational adjustments, and IHS Markit understands that these should be as relevant and as time-consuming as possible. Our goal is to support the stable development of institutions with the critical data and unique solutions we provide.

Learn more about XVA solutions from IHS Markit.

This article was first published on Risk.net on January 27, 2022.



Posted on February 07, 2022 by Hiroyuki YoshizawaExecutive Director and Head of Product, IHS Markit

Comments are closed.