More than two years after its publication by the Basel Committee, and a few months before its scheduled adoption, the new standardized approach for measuring counterparty credit risk is still in the process of being implemented. This article provides a brief introduction to this method, its expected benefits, and its actual impacts. It also details the potential difficulties associated with its implementation and the current status of its adoption in member countries.
The standardized approach for counterparty credit risk (SA-CCR) is a new computational method for exposure at default (EAD) under the Basel capital adequacy framework. It is due to replace both the current exposure method (CEM) and the standardized method (SM) starting January 1, 2017. Introduced by the Basel Committee for Banking Supervision (BCBS) in September 2013, it aims to address weaknesses in margining recognition, sensitivity, simplicity, and uniformity across national authorities.
This is the new SA-CCR formula for computing EAD:1
exposure at default = alpha x (replacement cost + potential future exposure)
SA-CCR inherits the 1.4 alpha factor from the Internal Model Method (IMM), used to obtain a loan-equivalent exposure conversion. Note that national supervisors may use their discretion to require a higher alpha based on a firm’s counterparty credit risk exposures. Furthermore, banks may seek approval from their supervisors to use internal estimates of alpha, subject to a floor of 1.2.
It also differentiates margined and unmargined cases, in the computation of both replacement cost (RC) and potential future exposure (PFE). RC is an estimate of the amount a bank would lose if the counterparty were to default immediately, while PFE reflects increases in exposure that could occur over time. PFE is the asset-classspecific product of a multiplier and an add-on. The new formulas allow for a better recognition of collateralization, as well as offsetting benefits.
SA-CCR supervisory factors and single-systematic-factor correlations have been thoroughly calibrated based on four exercises. The new add-on percentages are more conservative for equities and commodities, as shown in Figure 1.
Successful implementation requires a full understanding of the hedging set concept and of the margining processing under SA-CCR. The computation of the PFE add-on component is the most complex, as it varies widely depending on the asset class and subclass, collateralization, margin set, and netting set considered.
Identifying, sourcing, and arranging all the input data required for these calculations presents another challenge. Ensuring that the results obtained running SA-CCR match the expected figures from a theoretical standpoint is equally tricky. Moreover, it is important to verify that the exposure differences observed with the use of CEM and SM methods are accurate.
We asked some of our client banks about their perspectives on SA-CCR. Their feedback is as follows:
- The initial assessment timelines are considered reasonable, even though not all regulators have yet come up with a final implementation schedule.
- The September 2013 consultative paper issued by the BCBS successfully drew attention from several banks, whose modeling teams then submitted their inputs for incorporation into the final paper.
- The major challenge is posed by the SA-CCR computation data granularity requirements, which are much different from the CEM ones.
- The banks’ approach to collateralization is now more driven by the margin reform changes and central counterparty clearing.
As of March 2016, only the Saudi Arabia Monetary Agency has published a final rule, and only the Monetary Authority of Singapore has published a draft rule.2 Worldwide adoption status is summarized in Figure 2.
1,2 BCBS, April 2016.
Basel Committee on Banking Supervision. “Basel III: The standardised approach for measuring counterparty credit risk exposures: Frequently asked questions.” BCBS D333. August 2015.
Basel Committee on Banking Supervision. “Foundations of the standardised approach for measuring counterparty credit risk exposures.” BCBS WP26. August 2014.
Basel Committee on Banking Supervision. “Tenth progress report on adoption of the Basel regulatory framework.” BCBS D366. April 2016.
Basel Committee on Banking Supervision. “The Application of Basel II to Trading Activities and the Treatment of Double Default Effects.” BCBS 116. July 2005.
Basel Committee on Banking Supervision. “The non-internal model method for capitalising counterparty credit risk exposures.” BCBS 254. June 2013 (rev. July 2013).
Basel Committee on Banking Supervision. “The standardised approach for measuring counterparty credit risk exposures.” BCBS 279. March 2014 (rev. April 2014).