The new, low capital, Volcker-free prop trading book is… July 4, 2013 at 6:21 am

… the CVA book of course. From the new FED rules:

Therefore, the agencies clarify that non-credit risk hedges (market risk hedges or exposure hedges) of CVA generally are not covered positions under the market risk rule, but rather are assigned risk-weighted asset amounts under subparts D and E of the final rule [the standardised and IRB banking book rules].

4 Responses to “The new, low capital, Volcker-free prop trading book is…”

  1. If these positions were subject to the market risk framework, hedging accounting CVA could well be disincentivised, as those hedges would sit naked in the trading book (similar problem to what European banks are dealing with the CVA exemptions – that all credit hedges essentially sit naked in the trading book). So this Fed rule gets rid of the dilemma facing banks – to either hedge accounting CVA and potentially take on a large capital burden on the hedges; or not hedge and risk P&L volatility.

  2. To tone down somehow.. The accompanying footnote in the FED Rules (pp 428-429) states that “a banking organization needs to demonstrate rigorous risk management and the efficacy of its CVA hedges” for these not to fall under the market risk rule.

  3. Yeah, I know, I was being flippant: apologies. The accounting issue is a real one, and the capital problem will be solved hopefully by the fundamental review, but I do think the interim solution is sub-optimal. Putting the real CVA and its hedges into the TB might have made more sense.

  4. I think it’s also interesting in this context that the European banks’ response to the CVA problem is basically to wear it – another datapoint suggesting that people who view the whole field of regulation as one in which banks systematically game the models to such an extent as to make risk-weighting literally worthless are wrong.