Buy Side Expands Use of CVA

Terry Flanagan

Managing counterparty exposure in the form of credit valuation adjustment (CVA) is a capital markets imperative driven by regulatory requirements (Basel III, Dodd-Frank, Emir), accounting rules and the need to better manage risk.

Within the counterparty risk management realm, conducting CVA has emerged as a key requirement, and rims are climbing up the CVA maturity curve, according to a report by Dushyant Shahrawat, senior research director, capital markets at CEB Tower Group.

CVA is an adjustment to the value of OTC derivatives contracts that reflects the risk of counterparty defaults. An emerging trend is a growing interest in CVA from a broader range of capital markets firms.

“Rather than just being a concern for large sell-side derivatives desks, commercial banks and corporates, CVA is gaining interest among smaller capital markets firms, and new users like hedge funds and buy-side firms that were historically not involved with CVA,” said Shahrawat.

Lighthouse Partners, a global investment manager with $7 billion in assets under management, has expanded its relationship with SS&C GlobeOp to include CVA calculations for the firm’s managed accounts program.

With over 100 managed accounts, Lighthouse has built one of the largest managed account programs, which is supported by an operational, technological, legal and investment infrastructure.

“The addition of the CVA calculations is an important enhancement to the production efficiencies on our managed account program,” said Robert Swan, chief operating officer at Lighthouse Partners. “These services ensure the timeliness of applying a fair value to all positions in accordance with FASB accounting standards. Lighthouse is at the forefront of implementing industry leading risk mitigation initiatives.”

Robert Swan, Lighthouse Partners

Robert Swan, Lighthouse Partners

Lighthouse’s managed account program helps investors capture daily security level transparency, gain better asset control, aggregate broad risk exposures and achieve greater investment flexibility for its hedge fund allocations.
Combining its experience of being a long-term active hedge fund investor with the benefits of a managed account program has allowed Lighthouse to extend a custom suite of services to institutional investors.

Computing and managing CVA remains one of the most demanding tasks to perform, requiring enormous amounts of data, analytics, software and computing power, according to Shahrawat.

Calculating CVA sensitivity for a large sell-side shop can require 10-20 million valuations. “Large OTC derivatives desks with experience in managing counterparty risk have built CVA capability on top of core OTC derivatives operations, but even they struggle to fully manage CVA,” he said.

For other firms—commercial banks, insurance carriers, smaller brokers and asset managers—CVA remains a “work in progress.”
Though less than 16-18% of buy-side firms currently measure and manage CVA, interest is growing quickly as investment managers expand their involvement with risk analytics, and chief risk officers being focusing on enterprise-wide risk issues, including CVA.

“Expect to see, in the next few years, buy-side firms gradually replicate some of the enterprise-wide risk practices commonplace at sell-side firms, and CVA vendors responding by selling more to investment managers,” said Shahrawat.

The complexity of CVA calculations combined with a strong market focus on managing counterparty credit risk led Lighthouse to outsource its CVA calculations to SS&C GlobeOp.

Under the terms of the agreement, SS&C GlobeOp will perform CVA calculations and report to Lighthouse on a monthly basis. The methodology applied by SS&C GlobeOp utilizes market-observable credit spreads and is consistent with ASC Topic 820, US GAAP and IFRS 13 fair value guidelines. Netting agreements and collateralization are factored into the CVA calculations.

“CVA calculation has become an essential measurement for risk management and financial reporting, and can be a challenging process,” said Eric Reichenberg, managing director of valuation services at SS&C GlobeOp. “We enable our clients to become early adopters of industry best practices and overcome these challenges.”

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