Counterparty Credit Limits: An Effective Tool for Mitigating Counterparty Risk?

Gould, Martin; Hautsch, Nikolaus; Howison, Sam; Porter, Mason A.

doi:10.2139/ssrn.3043112

Cited by 4 publications

(2 citation statements)

References 35 publications

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“…However, under this framework an institution estimates the risk premium for each trading counterparty separately, which may be very challenging in practice (Gregory, 2010;Cesari et al, 2010;Barucca et al, 2020;Banerjee and Feinstein, 2021). Application of risk limits to manage CCR allows to set the maximum exposure that an institution faces from derivatives trading with any other counterparty (Gould et al, 2017a and2017b;Gregory, 2010). In the Polish literature there are also works on various risk limits, especially in the inter-bank market (Zając, 2002;Konopczak et al, 2011;Mrzygłód and Szmelter, 2014;Samborski, 2015) but still there is no comprehensive view on this topic from the perspective of the relationship between a financial institution and a non-financial counterparty.…”

Section: Literature Reviewmentioning

confidence: 99%

Utilization Schemes of the Pre-Settlement Risk Limits

Wybieralski

2024

JoFFL

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The purpose of the article is to investigate the selected method employed to manage the counterparty credit risk, namely the application of various risk limits. The aim is to recognize utilization schemes of the pre-settlement risk limits in the Polish OTC derivatives market in the relationship between a financial institution and a non-financial counterparty. They are used not only to cover the credit exposure but also to support and enhance the entire market risk management process and day-to-day operations in the financial institutions. Methodology. The research method comprises the analysis of recommendations of the Polish Financial Supervision Authority as well as reports, documents and market risk management principles of selected financial institutions (WSE listed banks). Results of the research. The study indicates two utilization schemes of the pre-settlement limit setup applicable both for daily and credit-related transactions. The first one assumes that the risk requirements remain unchanged during the contract lifetime, the second one considers variable risk requirements over time. Practical implications are discussed (in relation to a notional trade size, risk exposure and margining policy).

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Section: Literature Reviewmentioning

confidence: 99%

Utilization Schemes of the Pre-Settlement Risk Limits

Wybieralski

2024

JoFFL

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“…They cap the maximum exposure that an institution can face from any other counterparty. The application of counterparty credit limits (CCLs) enables institutions to specify an upper bound on each of their counterparty exposures and thereby to mitigate counterparty risk by selective diversification of their exposures (Gould et al, 2017a(Gould et al, , 2017bGregory, 2010). Treasury limits are granted on counterparty's request, after an appropriate credit application in a bank, usually similar to processes for working capital financing.…”

Section: Literature Reviewmentioning

confidence: 99%

Pre-Settlement Risk Limits for Non-Financial Counterparty in the Polish Over-the-Counter Derivatives Market

Wybieralski

2023

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Theoretical background: The 2008/2009 financial crisis, the COVID-19 pandemic outbreak in 2020 or the Russian invasion of Ukraine in February 2022, all these affected market volatility causing greater interest in counterparty credit risk (CCR) management especially in the OTC derivatives market. This study investigates selected method to mitigate the CCR, namely the application of various risk limits. The research is focused particularly on the pre-settlement risk that financial institutions face after transaction conclusion until the contract’s final settlement. Instead of one single limit there may be a wide range of different treasury limits (a multiple treasury limit setup) applied not only to cover the credit exposure but also to support and enhance the entire market risk management process and day-to-day operations in the financial institutions. Purpose of the article: The paper examines treasury limits employed to manage pre-settlement risk in the Polish OTC derivatives market in the relation between financial institution and non-financial institution. The current literature on this subject includes works on various risk limits, especially in the Polish inter-bank market, however, there is still no broader view on this topic from the analysed perspective. The study indicates different pre-settlement risk limits to be applied in practice both for daily and credit-related transactions considering multiple determinants, such as counterparty and financial instrument type, asset class or collateral form. Research methods: Research methods comprise the analysis of guidelines and recommendations of the Polish Financial Supervision Authority as well as reports, documents and market risk management principles of selected financial institutions. Particular attention is paid to the analysis of legal backgrounds on treasury limits in Poland and bank’s sources, such as master agreements, general conditions of cooperation in the field of treasury products, regulations, information brochures, etc. Selected data from the 2022 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Market Activity in Poland is used in the context analysis. Main findings: Different determinants of pre-settlement risk limit setup are identified and on this basis a directory of pre-settlement treasury limits is developed. The paper indicates also some challenges related to their practical application, concerning, for instance, the breaches of contractual terms (events of default), timely renewal of treasury limit or issues regarding the market risk estimation.

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Large-Scale Portfolio Allocation Under Transaction Costs and Model Uncertainty

Hautsch

Voigt

2017

SSRN Journal

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We theoretically and empirically study portfolio optimization under transaction costs and establish a link between turnover penalization and covariance shrinkage with the penalization governed by transaction costs. We show how the ex ante incorporation of transaction costs shifts optimal portfolios towards regularized versions of efficient allocations. The regulatory effect of transaction costs is studied in an econometric setting incorporating parameter uncertainty and optimally combining predictive distributions resulting from high-frequency and low-frequency data. In an extensive empirical study, we illustrate that turnover penalization is more effective than commonly employed shrinkage methods and is crucial in order to construct empirically well-performing portfolios.

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Counterparty Credit Limits: An Effective Tool for Mitigating Counterparty Risk?

Cited by 4 publications

References 35 publications

Utilization Schemes of the Pre-Settlement Risk Limits

Utilization Schemes of the Pre-Settlement Risk Limits

Pre-Settlement Risk Limits for Non-Financial Counterparty in the Polish Over-the-Counter Derivatives Market

Large-Scale Portfolio Allocation Under Transaction Costs and Model Uncertainty

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