Alert June 07, 2011

Basel Committee Modifies Credit Valuation Adjustment Capital Charge

On June 1, 2011, the Basel Committee on Banking Supervision (the “Basel Committee”) issued a press release announcing a “minor modification” of the credit valuation adjustment (which is used to cover the risk of loss caused by changes in the credit spread of a counterparty due to changes in its credit quality) as a result of a review of Basel III’s treatment of counterparty credit risk in bilateral trades.  The review showed that the standardized method as originally set out in Basel III in December 2010 could be unduly punitive for low-rated counterparties with long maturity transactions.  Therefore, to “narrow the gap between the capital required for CCC-rated counterparties under the standardized and the advanced methods, the Basel Committee agreed to reduce the weight applied to CCC-rated counterparties from 18% to 10%.”  All other aspects of the regulatory capital treatment for counterparty credit risk and credit valuation adjustment risk remain unchanged from the December 2010 Basel III text.  The Basel Committee noted that, by their estimates, the capital requirements for counterparty credit risk under Basel III will double the level required under Basel II (which addressed counterparty default and credit migration risk, but not mark-to-market losses due to credit valuation adjustments).