Counterparty Risk - Exposure Measurement, Mitigation and Credit Valuation Adjustment

• Counterparty Risk vs. Lending Risk
• Measuring Counterparty Risk using the Add-On Method
• Modelling Potential Future Exposure
• Transactional and Close-Out Netting
• Collateral Management and Margin Agreements
• Regulatory and Economic Capital for CP Risk
• Credit Valuation Adjustment of OTC Derivatives Portfolios
• Centralized Trading, Clearing and Settlement

At this seminar, we shall give you a good and practical understanding of methods and tools for measuring, pricing and managing the complex credit exposures that arise from transactions in OTC derivatives, security financing and various off-balance arrangements.

We start with general introduction to counterparty risk. We contrast this type of risk with traditional lending risk, and we give examples of transactions that give rise to counterparty risk exposure. We also present and discuss a number of case studies involving counterparty failures.

We then look at how counterparty risk can be identified and measured using a simple add-on method and a more comprehensive method where “potential future exposure” is quantified using an integrated model for market and credit risk. We demonstrate how simulation techniques can be used to generate loss distributions and to calculate Expected Exposure (EE), Expected Positive Exposure (EPE) and other important analytics.

Further, we explain how counterparty risk can be effectively managed. Methods include active counterparty credit monitoring, use of counterparty position limits, margining and the use of collateral. We also discuss the legal and operational risks that arise from using collateral and other arrangements. We explain and demonstrate how portfolios of OTC derivatives are “credit valuation adjusted” to take into account the relative credit qualities of the counterparties and how these adjustments should be taken into account in derivatives pricing.

Finally, we give an overview of regulatory and industry developments towards creating a better infrastructure that should lead to a reduction in counterparty and systemic risk. Initiatives include clearing facilities for OTC derivatives, improved accounting standards, and enhanced monitoring and risk management, and strengthened capital standards.

 

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 09.45 Counterparty Risk – General Introduction and Overview

• Contrasting Lending Risk with Counterparty Risk
• Examples of Transactions that Expose Parties to Counterparty Risk
  • OTC derivatives
  • Securities lending and securities financing transactions
• Counterparty Risk Case Studies
  • Bank Herstatt, Lehman Brothers, AIG, KfW

09.45 - 10.30 Measuring Counterparty Risk

• Counterparty Risk – Building Blocks
• Exposures Definitions
• The Add-on Method
  • The Basel CEM and the standardized approach
  • Calculating Current Exposure + add-on: Examples
  • Calculating RWA and regulatory capital charge under the CME and the standardized approach

10.30 - 10.45 Coffee Break

10.45 - 12.00 Measuring Counterparty Risk (continued)

• Modelling Potential Future Exposure
  • Monte Carlo simulation engines
  • Calculating EE, Effective EE, EPE and Effective EPE
• Examples, Simulations and Small Exercises

12.00 - 13.00 Lunch

13.00 - 14.30 Managing Counterparty Risk

• Active Counterparty Credit Monitoring
• Trade Approvals Against Credit Line Limits
• Early Termination of Deals
• Netting
  • Transactional vs. close-out netting
  • Levels of netting
  • Legal framework: ISDA Master Agreement and supporting documents
  • Events of default and termination events
  • Calculation of amount
• Small Exercise

14.30 - 14.45 Coffee Break

14.45 - 15.30 Managing Counterparty Risk (Continued)

• Collateral Management
  • ISDA “Credit Support Annex”
  • Legal and operation risks
• Collateralization practices: a Global Assessment (ISDA survey)
• Modelling Collaterized Exposure
  • Monte Carlo procedure
  • Shortcut method

15.30 - 16.15 Regulatory and Industry Initiatives to Reduce Systemic Risk through Improved Market Infrastructure

• US and European Regulatory Initiatives
• Clearing OTC Derivatives through Central Counterparties (CCPs)
• ISDA “Big Bang” Protocol for Streamlining CDS Settlements

16.15 - 16.30 Summary, Evaluation and Termination of the Seminar