ISDA, the Global Financial Markets Association and the Institute of International Finance (the "Associations") offered recommendations on the Bank for International Settlements (BIS) Basel Committee's proposed revisions to the bank regulatory credit valuation adjustment ("CVA") risk framework.
In a BIS consultative document published in November 2019, the Basel Committee proposed several "limited adjustments" to the CVA risk framework. Stakeholders were asked to provide feedback on the proposed adjustments to the Basel III standards by February 25, 2020.
In a letter to BIS, the Associations recommended setting the CVA multiplier at one, to address, at least in part, the calibration issues outlined in the BIS consultation. The associations asserted that:
- there is "no justification" for applying a multiplier to the CVA standardized approach ("SA-CVA") framework;
- the expected increase for CVA would be lowered if the CVA multiplier was removed; and
- the CVA framework could have a negative impact on capital markets and end users using derivatives for hedging purposes if the BIS does not adjust its framework accordingly to the industry associations' findings from the Quantitative Impact Study.
The Associations cautioned the BIS that the CVA framework's "over-conservatism" and lack of risk sensitivity could create (i) adverse implications on liquidity in the derivatives market, (ii) slow growth in the capital markets and (iii) reduce incentives for the optimal hedging of CVA risk. The Associations urged the Basel Committee to consider (i) revising the granularity of the counterparty credit spread risk weights, (ii) increasing recognition of CVA Index hedges in order to reflect their usage and hedge systematic credit spread risk, (iii) incentivizing responsible hedging and (iv) aligning the Basel rules with industry practice.
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