RiskTech Forum

Wolters Kluwer: SA-CCR: The importance of integration

Posted: 7 March 2019  |  Source: Wolters Kluwer

The steady rollout worldwide of the Standardized Approach for Measuring Counterparty Credit Risk (SA-CCR), a revised rule under Basel III applied to calculate the exposure at default (EAD) of derivatives, means banks need to consider how to integrate the standard into their overall regulatory approach. Regardless of whether they’re active in markets where SA-CCR is already adopted or about to be implemented, the complexity of the standard, as well as its potential impacts on other aspects of compliance and the business, argue for institutions to prioritize developing a comprehensive response that will prove sustainable for the long term.

In the US, the Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC) recently proposed adopting SA-CCR as a more accurate and risk-sensitive measure to calculate EAD for derivatives, and making it mandatory for banks currently subject to advanced approaches to risk calculations. In Europe, SA-CCR will be rolled out as part of CRD V, which as we’ve noted previously is in effect imminent. Other key markets, including Singapore, Australia and Switzerland, have either implemented SA-CCR or will do so through 2019-2020. 

Of course, not everything will necessarily proceed to plan. The proposal by US regulators, for example, is open for commentary until 15 February of this year and may very well be adjusted to take banks’ concerns into account. Nonetheless, as SA-CCR is part of a broad global trend, substantial alterations or delays are unlikely.

New depths of data
So banks need to respond – but how can they do so most effectively? To explain that, we need to look at what SA-CCR is, and its raison d'être. It is designed to replace the more simplistic current exposure (CEM) and standardized methods of calculating potential exposures from derivatives trades, using new methods to calculate the EAD of derivative netting sets as a function of replacement costs and potential future exposures.

In short, in addition to enhancing risk sensitivity, SA-CCR is designed to accurately reflect the collateral and netting effect on exposures and cover a wider range of derivative transactions.

Unmargined and margined SA-CCR calculations

SA-CCR: The importance of integration Figure 1
Figure 1: Unmargined transactions

SA-CCR: The importance of integration Figure 2

Figure 2: Margined transactions

SA-CCR, an isolated challenge?

SA-CCR informs and will affect other elements of the Basel III/CRD V framework, such as capital requirements for market risk, leverage ratio and large exposures, the output floor and ultimately regulatory reporting.

Direct and Indirect Impacts of SA-CCR

SA-CCR: The importance of integration Figure 3

This interdependency and SA-CCR’s far-reaching impact mean that though it is designed to reduce complexity, the reality on the ground may be different. The experience of our clients who have undergone SA-CCR implementations shows the new approach requires substantially more data points, such as trade directions and hedging set definitions, and more complicated calculations than CEM.

Sourcing, calculating and transforming the necessary data input for SA-CCR can therefore prove a significant challenge for existing processes and infrastructure, particularly where relevant information is spread among disparate legacy systems. SA-CCR is also likely to require closer personal and technological coordination between departments and functions like finance and risk.

When planning their SA-CCR projects, banks should therefore consider solutions that support closer connections among finance, risk and regulatory reporting, forging processes and structures capable of keeping pace with an ever-changing commercial and supervisory environment. The best solutions will include a dedicated finance, risk and reporting data warehouse that pools risk, finance and other key functions; integrate old systems with new ones; and pay particular attention to elements like data lineage.

Recognizing business realities

Banks also need to consider SA-CCR’s potential business impacts. Some are likely to be positive, such as a more accurate picture of risk overall and lower exposures associated with centrally cleared transactions. Others may be problematic, including reduced benefits from netting and higher counterparty risk exposure in unidirectional trades.

There are clear arguments for beginning to evaluate and address those impacts sooner rather than later. Adopting or commencing trial runs of SA-CCR now will enable banks to identify and analyze effects on exposure and capital adequacy scenarios, and adjust derivatives policy and processes to mitigate these effects if needed. Early adoption will also build understanding of the data and technology requirements SA-CCR involves, and to establish where existing systems and processes may be adequate or where additional data points or integrated risk calculators will be needed.

Many institutions will adopt external solutions to bolt on the additional capabilities SA-CCR demands. But this can present an additional source of complexity, if a solution is a struggle to integrate with existing systems or not sufficiently integrated itself. Banks should ensure a SA-CCR solution covers all required parameters; offers the transparency needed to source and track data throughout its lifecycle, to support more granular calculations; and, bearing in mind SA-CCR’s interdependency with other aspects of Basel III/CRD V, is part of a broader toolkit that extends to all aspects of this regulatory architecture. Putting the right solutions in place early gives banks the opportunity to go beyond simply keeping up with requirements to grasping the business implications of the new data points SA-CCR will create. Factored into business analytics, these calculations can help institutions reach new levels of insight into trends in risk and on the balance sheet.

So, when to (re)act?

When it comes to SA-CCR and Basel III/CRD V as a whole, the banks that act quickest may not necessarily win the race. But they will certainly have a running start. Firms should also take into account that a ‘one-problem-at-a-time’ approach that addresses SA-CCR projects in isolation rather than in the context of broader regulations such as Basel III/CRD V, will likely result in silos and data gaps - as well as possible duplication, with multiple departments producing the same information in different ways and with different results. This is not only a possible waste of time and resources, but may create inconsistencies that make the data appear untrustworthy to regulators and executives within the firm that are counting on it to support strategic decisions.