Banks threw out the standard playbook for hedging the counterparty risk of interbank derivatives portfolios in the frenetic days leading up to UBS’s takeover of Credit Suisse on March 19.
In the accounting statement, credit valuation adjustment (CVA) measures the point-in-time value of uncollateralised or imperfectly collateralised derivatives counterparty credit risk. It depends on both the credit quality of the counterparty and the market risk factors of the underlying trades, such as foreign exchange and interest rates.
When counterparty credit spreads deteriorate, CVA becomes more sensitive to market movements, and banks must increase their interest rate and foreign exchange hedges to compensate.
This was the position CVA desks found themselves in last month when a huge move in Credit Suisse’s single-name credit default swap…
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