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FRM Part II · FRM Exam Part II · Credit Value Adjustment

Under the Basel III CVA capital framework, a bank buys CDS protection on a counterparty and wants capital relief on its CVA risk charge. Which hedge is generally recognised as eligible?

Single-name CDS on the counterparty, and index CDS subject to basis limitations, are the recognised eligible CVA hedges for capital relief. Instruments unrelated to the counterparty's credit spread, such as equity puts on the bank's shares or unrelated sovereign swaps, receive no recognition.

  1. AA single-name CDS referencing the counterparty, or an index CDS with limitationsCorrect
  2. BAn equity put option on the bank's own shares
  3. CA total return swap on a sovereign bond unrelated to the counterparty
  4. DAny interest rate swap used to manage the bank's funding costs

Explanation

Basel CVA rules recognise credit hedges such as single-name CDS and index CDS referencing the counterparty (with basis limitations) as eligible for reducing the CVA capital charge. The other instruments are not credit hedges of the counterparty's spread and do not qualify.

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