As Complex As Fibonacci Numbers? The New Basel IV SA-CCR Approach

With Basel IV, the Basel Committee on Banking Supervision (BCBS) has outlined the standardized approach to counterparty credit risk (SA-CCR) with the intention of replacing the previously existing approaches, including the current exposure method (CEM) and the standard method (SM). The new SA-CCR approach will be mandatory for all over-the-counter derivatives, exchange-traded derivatives, and long settlement transactions. Financial institutions around the world will be required to use the new methodology to calculate their CCR exposures and corresponding capital reserves, leaving them with an altered capital profile.

sa-ccr approach

Complex Calculations Do Not Add Up To A Simple Sequence

Furthermore, to comply, banks will need to incorporate a variety of complex calculations — including new add-on potential future exposure (PFE) and replacement cost (RC) calculations that are necessary to compute exposure at default (EAD). Not only are calculations under the Basel IV SA-CCR approach more complex, requiring more data attributes, they are also more interdependent with other parts of the capital framework — including large exposure calculations. Financial institutions should not underestimate the new methodology’s operational implications across their organizations — this will not be as simple as 1+1.

G-SIBs Are Most Affected…

A recent Basel monitoring report found that under the new SA-CCR rules, G-SIBs may see their CCR charges increase 27.2% versus current levels (per BCBS, April 2020). They will also need the ability to run the calculations on a regular basis — even as often as daily — to ensure they do not exceed the capital limits set by regulators. Although G-SIBs will be most affected, all financial institutions will need to implement the new calculations and run impact analysis exercises as soon as possible to understand how the SA-CCR approach will affect them.

…But Small Institutions Cannot Be Complacent

In Europe for example, calculation changes for smaller institutions by methodology are as follows:

Simplified Approach: Authorized financial institutions considered to be small or less complex can follow simplified SA-CCR calculation methodologies. This includes firms with on/off-balance sheet derivative business of <€300M where this is <10% of their total assets.

Original Exposure Method (OEM): For firms with very limited derivatives business there is an even simpler alternative, the OEM. Criteria outlining who will qualify is yet to be finalized but will depend on an institution’s contract netting agreements.

And, Adopting The SA-CCR Approach Takes Different Paths Globally

In Asia-Pacific for example, Australia and Singapore have already fully implemented SA-CCR. But, there are recent developments. On May 29, 2020, the Hong Kong Monetary Authority (HKMA) mandated all Hong Kong domiciled banks to adopt SA-CCR by June 30, 2021. With its mandated full adoption of the approach, Hong Kong aligns itself with the Basel framework, a stance that can bolster its competitiveness as a financial center. It will be interesting to see whether other jurisdictions follow suit.

Universal Agreement: 0,1,1,2,3,5,8 … Is Genius

Regardless of where they are located and into what category they fall, institutions required to comply with Basel SA-CCR will still have to implement new calculations and report more frequently than before. Like solving the riddle of a Fibonacci sequence, completing complex calculations and assessing interdependencies across their capital structures will become a cumbersome process if financial institutions are not prepared.

Given the complexities of the new SA-CCR approach, financial institutions must manage the implications across both risk and finance departments. There is no universal agreement on who is best equipped to handle the process, with some suggesting that SA-CCR requires complex data and thus risk departments can best analyze and explain relevant risk sensitivities. On the other hand, when regulatory reporting is already done by finance, they are uniquely placed to manage the SA-CCR reporting process. Regardless, risk and finance departments will both be key players in satisfying new SA-CCR requirements. Their collaboration — as well as with legal, operations, compliance, data, and technology teams — is critical for successful, institution-wide implementation of SA-CCR. No genius number sequencing required!

Like Leaves On A Stem

Just as leaves in nature arrange themselves in mathematical harmony, this same synergy is needed across a financial institution’s processes to seamlessly apply the new SA-CCR approach. Financial institutions require transparent data, robust analytics, a scalable, technology-driven approach, and end-to-end processes that enable confident compliance. And as global financial markets adjust to a new normal after COVID-19 disruptions, it is even more important than ever for organizations to have transparency into their data, calculations, and risk, and be enabled to optimize efficiencies, and manage change across their organizations.

Order From Chaos

AxiomSL’s SA-CCR solution, running on the ControllerView® data integrity and control platform, delivers the processes, calculations, and controls that empower financial institutions to improve risk management and data governance and strengthen transparency and disclosures. AxiomSL’s solution for SA-CCR calculations provides seamless functionality and prompt adoption of relevant updates for new calculations needed to compute EAD. Full support for impact analysis is also built in. Underpinned by AxiomSL’s extensible, flexible data dictionaries, the solution automates the computation of exposure at default (EAD), using the new SA-CCR methodology. It also provides the new potential future exposure (PFE) calculations (including add-on calculations for different asset classes) and the new replacement cost (RC) calculations mandated for both margined and unmargined trades. Furthermore, AxiomSL’s dictionaries and methodologies ensure the required consistency across Basel framework calculations, for example, FRTB and SA-CCR common asset class allocations.

Since the solution allows financial institutions to run the new SA-CCR calculation logic in parallel with their current calculation logic, they are enabled to migrate smoothly from their incumbent calculations to new SA-CCR requirements. With AxiomSL’s proven technology, financial institutions can future-proof their approach to risk and regulatory compliance and confidently meet the requirements that regulators demand in the Basel IV evolving landscape and a post-COVID-19 new normal.

To solve the equation: complex calculations + interdependencies + change management = Contact us today.

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