Standardized approach (counterparty credit risk)

Not to be confused with Standardized approach (credit risk).

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Pillar 1: Regulatory capital
Capital requirement Capital ratio Leverage ratio Tier 1 Tier 2 Credit risk SA-CR IRB F-IRB A-IRB EAD SA-CCR IMM CCF Market risk Standardized IMA CVA vol BA-CVA SA-CVA Operational risk Basic Standardized AMA
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The standardized approach for counterparty credit risk (SA-CCR) is the capital requirement framework under Basel III addressing counterparty risk for derivative trades. It was published by the Basel Committee in March 2014. See Basel III: Finalising post-crisis reforms.

The framework replaced both non-internal model approaches: the Current Exposure Method (CEM) and the Standardised Method (SM). It is intended to be a "risk-sensitive methodology", i.e. conscious of asset class and hedging, that differentiates between margined and non-margined trades and recognizes netting benefits; considerations insufficiently addressed under the preceding frameworks.

SA-CCR calculates the exposure at default, EAD, of derivatives and "long-settlement transactions" exposed to counterparty credit risk, where EAD = α × (RC + PFE). Here, α is a "multiplier" of 1.4, acting as a buffer to ensure sufficient coverage; and:

RC is the "Replacement Cost" were the counterparty to default today: the current exposure, i.e. mark-to-market of all trades, is aggregated by counterparty, and then netted-off with haircutted- collateral.
PFE is the "Potential Future Exposure" to the counterparty: per asset class, trade-"add-ons" are aggregated to "hedging sets", with positions allowed to offset based on specified correlation assumptions, thereby reducing net exposure; these are in turn aggregated to counterparty "netting sets"; this aggregated amount is then offset by the counterparty's collateral (i.e. initial margin), which is subject to a "multiplier" that limits its benefit, applying a 5% floor to the exposure.

The SA-CCR EAD is an input to the bank's regulatory capital calculation where it is combined with the counterparty's PD and LGD to derive RWA; Some banks thus incorporate SA-CCR into their KVA calculations. Because of its two-step aggregation, capital allocation between trading desks (or even asset classes) is challenging; thus making it difficult to fairly calculate each desk's risk-adjusted return on capital. Various methods are then proposed here. SA-CCR is also input to other regulatory results such as the leverage ratio and the net stable funding ratio.

References

Basel Committee on Banking Supervision (2018). "Counterparty credit risk in Basel III - Executive Summary". www.bis.org
Basel Committee on Banking Supervision (2014-03-31). "The standardised approach for measuring counterparty credit risk exposures (BCBS 279)". www.bis.org. Retrieved 3 May 2018.
FIS (2017). "Allocating SA-CCR fairly", www.fisglobal.com.

Financial risk and financial risk management