MVA: Rationale and Practical Calculations as Margining Rules Tighten

In the wake of regulatory initial margining requirements, counterparty credit risk has reduced and thus CVA has declined. However, increased dealer costs associated with IM have forced banks to take a closer look at its impact on profitability, giving rise to the Margin Valuation Adjustment (MVA).

On September 20^th, Numerix Director of Quantitative Research, Andrew McClelland, Ph.D., explained the pricing and profitability impacts of this shift for banks, explored some of the complexities posed by initial margin requirements and the margining processes for cleared and non-cleared trades, and offered an introduction to MVA calculations and the complex computational challenges they present.

Dr. McClelland covered the following topics:

• Overview of Initial Margin and How it Helps to Reduce Counterparty Risk
• Initial Margin Requirements
  • Cleared Trades and Clearing Member Responsibilities
  • Regulatory Initiatives for Non-Cleared Trades
  • Evidence of Initial Margin Impact on Cleared Trades
• ISDA’s SIMM
  • Motivations and High-Level Overview
  • Sensitivity Definitions and Aggregation Hierarchy
• Margin Valuation Adjustment
  • How do We Capture the Cost of Initial Margin?
  • Aggregation Level, Incremental Impacts and Initial Margin on Hedges
  • Simulating Future Sensitivities for SIMM and CCH Initial Margin
• Key Takeaways

Initial margin has long been a requirement for counterparties clearing trades through central clearing houses and is known to have an impact on dealer costs. As mandatory bilateral posting of initial margin for non-cleared trades is being phased in, bilateral initial margin is likely to have even more pronounced impacts on dealer costs. Banks that don’t begin updating pricing platforms to reflect the anticipated costs of posting initial margin will be at risk of incurring losses through the long-term effects of these costs on the portfolio.

Margin Valuation Adjustment (MVA) prices in these costs by projecting the expected bilateral initial margin requirements for a trade. Calculating MVA will require the simulation of ISDA’s SIMM over the life of the trade, or portfolio, which presents certain computational challenges that render it more of a burden than CVA calculations. Specifically, it will be necessary to simulate the sensitivities of that trade over its entire life. One benefit of examining this problem is that simulated sensitivities could also be used to approximate clearing-house initial margin, yielding a reasonable approach to computing clearing-house MVA.