Banks will not be hit with a capital charge for credit value adjustment (CVA) on trades conducted with European debt management offices and central banks under proposed amendments to European bank capital rules.
Banks will not be hit with a capital charge for credit value adjustment (CVA) on trades conducted with European debt management offices and central banks under proposed amendments to European bank capital rules.
The exemption appears in the latest 816-page version of the fourth Capital Requirements Regulation and Directive, drawn up by the Council of the European Union (EU). In an earlier council draft, an exemption had been given to non-financial counterparties - which lawyers had interpreted to mean corporate users.
The latest version - published on March 1 - replaces that with an exemption for counterparties referred to in article 1, paragraphs 4 and 4a of the European Market Infrastructure Regulation (Emir). These include the European System of Central Banks and other EU national bodies that perform a similar function, European sovereign debt management offices, the Bank for International Settlements and certain multilateral development banks.
Any carve-out will be welcomed by many bankers, who had complained about a possible feedback loop between the CVA capital charge methodology and credit default swap (CDS) spreads. In simple terms, changes in CDS spreads are used as an input in the CVA capital calculation - but CDS contracts are also accepted as a hedge in certain circumstances. As a result, some have warned that the CVA charge would prompt heavy buying of CDS protection by dealers - which could cause CDS spreads in less liquid names to widen, so increasing the CVA exposure and prompting further protection buying.
The problem is made worse because market risk hedges are not taken into account when calculating exposure for the purposes of the CVA charge, dealers say. That means any move in interest rates that causes the market value of the trade to increase for the bank would result a higher CVA capital charge - unless the dealer buys more CDS protection.
