XVAs and implications for the buy-side

XVA is a term used to reflect the various ‘valuation adjustments’ that are made to the price of an OTC derivative transaction to accurately value the costs of the contract.

While still a new concept for the buy-side, XVAs are now relatively well known on the sell-side. Following the financial crisis, the costs associated with trading OTC derivatives were brought to the forefront for banks – credit risk used to be free, now it’s not. XVAs are a means of quantifying credit risk (CVA) and other costs associated with trading OTC derivatives.

The current market standard valuation adjustments are CVA, DVA, FVA, MVA and KVA.

Increasingly, these XVAs are being passed on to buy-side clients, who are getting charged by their provider banks for reasons that may not be clear to them yet.

Implications for the buy-side

• New deal pricing – Banks are now pricing a variety of XVA adjustments when they trade. Price takers could potentially feel that they must accept the charges without understanding them.
• CSA renegotiations – Banks are incentivised to renegotiate their CSAs to reduce the CVA charges they’re forced to hold, and they will potentially pay significant fees to counterparties to amend the terms of their agreements.
• Accounting requirements – IFRS requires CVA adjustments to be included in the valuation of your OTC derivatives. Auditors are putting more and more pressure on corporates to start IFRS accounting regardless of the materiality of the CVA charge.
• Regulatory pressure – While a price taker may not have the same regulatory requirements as a bank, regulations such as Basel III and FRTB indirectly increase the cost of trading for corporates, fund managers and other buy-side firms.

Why should buy-side firms analyse XVAs?

As costs of trading OTC derivatives continue to increase, buy-side firms need transparency into what they’re being charged by their provider banks and why.

With the web-based triCalculate service, buy-side market participants can easily, quickly and accurately calculate the XVA numbers themselves. Through understanding XVA costs, buy-side firms can:

• Challenge unreasonable figures with meaningful numbers.
• Optimise trading by ensuring they’re trading with the right counterparties and not incurring charges needlessly.

For more information about how triCalculate can help buy-side firms, view the webinar or the factsheet, or book a free demo. You can contact us at tricalculate-enquiry@nex.com.