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Could you please explain MVA and derivatives pricing in the new regulatory environment?

MVA is the latest addition to valuation adjustments and represents an extra funding costs due to the need to post initial margin – either CCP IM for cleared or SIMM IM for non-centrally cleared derivatives. MVA is a logical extension of the XVA framework and is primarily driven by two global regulatory initiatives that originated at the G20 meeting in London in 2009 in the immediate aftermath of the financial crisis: push for central clearing and the margin reform. The other G20 initiatives that form the new regulatory environment are increased capital requirements, extensive reporting and strong incentives for trading on the regulated exchanges. All these factors influence derivatives pricing with various XVA components absorbing the funding costs (FVA, MVA), capital costs (KVA) and the cost of buying credit protection on counterparty exposure (CVA). Whether it is right or wrong to include all these costs into derivatives valuation is still open to debate (though there is an emerging consensus) but the need to fully recognise these costs is obvious.

What are the most efficient methodologies for PruVal to avoid falling behind in such a competitive marketplace?

The funding costs are real. This also includes the capital funding costs. Any dealer that prices derivatives in the case of bilateral trading or client services in the case of clearing and intermediation below the level that covers the funding costs is running an unsustainable business. We have already witnessed several high profile exits from the clearing business by major clearing brokers. Competitive pressure definitely puts a cap on what portion of XVA a dealer can include into the price but at the same time the funding costs provide the floor that determines pricing level at which a dealer is prepared to walk away from the trade because it is not economical. Efficient market should be able to balance these competing forces. Whether or not full XVA should be reflected in prudential valuation for accounting purposes is subject of the ongoing industry discussion.

What are the emerging practices for MVA in a wider XVA context?

First, dealers started to compute MVA which is a non-trivial task if done properly. Secondly, what can be measured can then be optimised. The fact that MVA is always a cost (unlike FVA that can be either a funding cost or a funding benefit) comparable in magnitude to all other XVA components motivates XVA quants to find a way of flattening out the expected IM time profile thus reducing the expected IM funding costs.

What would you like to achieve by attending the 4th Annual Fair and Prudent Valuation for Derivatives conference?

I have mentioned emerging consensus among market participants regarding the recognition of various XVA components as valid adjustments to the derivatives valuation that should be fully taken into account. It would be interesting to hear from the wide range of speakers to which extent they are prepared to give MVA the same status as FVA and what they believe would be the impact on existing business models.