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Counterparty Risk, Credit Exposure and CVA - Dr. Jon Gregory - YouTube
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at London Financial Studies we focus
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exclusively on capital markets our
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programmes offer practical learning to
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professionals from all over the world
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public courses are delivered in London
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New York and Singapore our teachers are
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leading experts in their fields with a
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wealth of practical knowledge they are
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skilled communicators who can get the
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message across quickly and effectively
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dr. John Gregory is a senior
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practitioner in quantitative finance and
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has been on the LFS faculty since 2008
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he is a regular speaker at international
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conferences and author of the highly
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acclaimed book counterparty credit risk
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the new challenge for global financial
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markets the markets have known about
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counterparty credit risk for many years
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over well over a decade the Asian crisis
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which occurred around the period of 1998
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was a bit of a wake-up call for this
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area but after that it's probably true
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that not a huge amount of emphasis was
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put on counterparty credit risk other
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aspects like market risk had a huge role
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to play and var for example received a
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lot of attention but it wasn't until the
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more recent crisis that counterparty
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credit risk really became such an
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important thing for banks and the
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failure of institutions like Lehman
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Brothers and the bailouts that were
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applied to so many financial
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institutions and sovereigns really
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taught everyone the counterparty credit
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risk was a very very big deal for the
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markets
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the most important implication that
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institutions are considering is the
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capital they have to hold if you don't
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get it right or if you don't manage
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counterparty credit risk in the right
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way then the capital you'll have to hold
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against the risks you face could be
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extremely large to the level at which
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you may not be able to carry on business
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in certain areas even you may not be
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able to carry on business at all so a
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huge amount of the need to manage
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counterparty risk properly is around
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regulation around getting the right the
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low capital requirements such that your
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business will not be starved of oxygen
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if you like
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obviously there is an issue of best
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market practice and there's an issue to
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avoid the sort of losses that we've seen
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from counterparty risk during the crisis
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so when monoline insurers failed they
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had a triple-a rating but some of them
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failed financially when AIG came very
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close to failure when sovereigns have
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either failed defaulted like Greece
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house'll come very close to defaulting
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all of these cases are potentially
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crystallizing very large counterparty
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risk losses for banks and other
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financial institutions so irrespective
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of the capital you have to hold you want
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to be the bank that's in the situation
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when someone like Lehman or am online
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insurer or a sovereign has basically
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defaulted that you're not one of the
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people suffering the largest losses you
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anticipated that you mitigated against
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that you quantified that properly and
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because you did that properly then
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you're not facing the kind of losses
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that you would otherwise be facing
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this paradigm change in derivatives
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pricing of which counterparty risk is a
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key part has been very significant if we
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went to let's say five years ago before
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the crisis and looked at the pricing of
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something very simple a vanilla like an
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interest rate swap then we would expect
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pretty much everyone to agree on the
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price of that without too much issue
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without too much argument about how that
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was actually priced and some from a
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valuation perspective everything was
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simple when everyone agreed now even if
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we take that same very simple situation
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of course we have counterparty risk
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which is normally expressed by CVA and
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DVA but you also have related issues
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like funding often called FPA and
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potentially collateral optimization
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issues sometimes even called collateral
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or collateral vva if you like and then
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finally learn to me we have the point
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that there is no such thing anymore is a
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risk-free price so when we used to talk
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about risk-free pricing then we used to
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think about probably discounting cash
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flows on Libor rates but we now realize
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that liable rates are very far from
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risk-free and therefore we have to think
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about what's often known as OAS or dual
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curve discounting so it's only by
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putting all of these components together
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the OIS discounting the CVA the DVA the
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FPA the collateral optionality putting
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them all together and understanding how
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they relate to one another that you can
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really start to understand what price of
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even a very simple derivative is in
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today's market
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a lot of market practitioners at the
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moment are starting from the regulatory
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point of view it's not at all surprising
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given what happened in the crisis that
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regulators have clamped down very
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heavily on counterparty credit risk and
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are charging more capital to banks for
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the risks as they face and are putting
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regulation around the OTC derivatives
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market this is a very important thing
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for banks and financial institutions
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putting a strategy together around CVA
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of course I need the theoretical side
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they need to know what other banks are
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doing and what best market practice is
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but they also need to be able to look a
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little bit into the future and see how
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things might be changing this LFS course
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explores counterparty risk and CVA in
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detail concepts for today's market are
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built up step by step and key ideas are
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explored with spreadsheets the delegates
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can take away
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I was lucky enough to work in the area
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of counterparty risk for a number of
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years starting way back over ten years
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ago when this area was really in its
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infancy and over the last three to four
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years I've consulted for banks globally
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which has allowed me in this area to see
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all of the different angles of what
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different banks and other financial
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institutions are doing hearing what the
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regulator's are thinking being
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interfaced with for example what other
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companies like software companies may be
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doing in this space and that keeps me
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obviously up to date with everything
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that's going on in the counterparty
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space in this course what what we
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obviously really want to do apart from
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just tackling the theory is give
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practical implementations of that theory
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so obviously we go through the relevant
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theory this is not a mathematical course
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but we go through the necessary
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quantitative side of how you
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for example model CVA how you compute
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CVA secondly all of that is done in a
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very practical way so we don't just talk
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about a formula for pricing CVA we look
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at real examples we look at the impact
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of things like netting collateral which
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is so important we look at DVA we look
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at wrong-way risk all of the components
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you have to put together with all the
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knowledge that I gained over the years
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and through seeing through consulting
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the practices that financial issues that
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are adopting what I've done is boil that
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down into some relatively simple
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examples that we can go through in the
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course and time is set aside to look at
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these so delegates who have particular
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problem or don't understand something
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there is time to go through it in a bit
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more detail and they can take the
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examples away they can customise them to
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their own specification whether
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someone's interested in looking at
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exposure calculations CVA calculation
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quantifying wrong-way risk the impact of
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netting your collateral funding value
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adjustment they're examples of all of
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these things which are implemented in a
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fairly simple way so it's possible to
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get a really good intuition on how
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things work and what the sort of
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behavior is those practical examples are
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aimed at being as close as possible to
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what you would be doing in real life but
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they're done on spreadsheets so there
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pretty easy
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typically obviously people coming this
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course are more often from banks but
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that's not always the case they may come
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from other large financial institutions
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or maybe even come from end-users of OTC
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derivatives like a large corporate a
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large energy company or something like
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that obviously a lot of people come from
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risk management so they may have already
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knowledge on something like market risks
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but they're fairly new to counterparty
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risk quite a lot of people come from the
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front office that might be someone in
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the front office who is intimately
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involved with a CVA trading desk but it
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also might be someone who's not
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intimately involved in CVA for example
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it might be a marketer who is going to
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be looking at CVA pricing on
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transactions they don't have to be the
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world expert in CV Abel they need to
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know what's driving the price of the
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transactions that they actually do with
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clients and how the CDO is going to
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affect them and what transactions are
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going to be still viable and what maybe
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are not going to be so viable and then
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after that we probably come to the more
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outside roles so people like the quant
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team who would be building CVA pricing
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models the ITU would putting be putting
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together infrastructure
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given we're in a state of flux at the
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moment we're counterparty risk is
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suddenly grown into this enormous
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subject regulators have been all over it
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and imposing many many different rules
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and capital requirements we try and give
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the view of where is this all going to
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lead us what should you believe in very
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clearly and what should you maybe not
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believe in and think well this is a rule
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that I may have to follow but I don't
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think it has any economic meaning and
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with all of that together I think
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someone should come away from this
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understanding all the theory around the
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area understanding market practice but
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also having a good feel for where this
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area is going to lead them in the future
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