While the incoming Basel market risk rules will ease capital consumption of counterparty credit hedges for uncollateralised derivatives trades, the lack of an equivalent carve-out for funding costs could create hedging challenges for dealers.
Banks’ credit and funding-related derivatives exposures can be inflated by changes in the market price of derivatives positions. This risk is hedged by the derivatives valuation adjustment (XVA) desk, which typically puts on interest rate and foreign exchange hedges as a mitigant. While US and Canadian rules exempt those trades from risk-weighted asset calculations, European rules treat those hedges as naked positions in the book – a source of great…
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