Quick Takes: Using SACCR to monitor Counterparty Credit Risk

Ali Curi: Hi everyone, and welcome to ION Markets Quick Takes. I’m Ali Curi, and every week, along with my guests, Amir Khwaja and Chris Barnes, we take a quick dive into the headlines on the Clarus FT blog. Let’s get started. Hi Amir. Hi Chris.

Amir Khwaja: Hey Ali.

Chris Barnes: Hey Ali, how are you doing?

Ali Curi: Doing great. Welcome back to Quick Takes.

Chris, let’s start with you. What are your Quick Takes for this week? Which headline from the Claris FT blog would you like to discuss?

Chris Barnes: All right, Ali, in my bid to become the number one blogger on SACCR, I’m going to be talking about SACCR again. This time I’m taking a little bit of a different angle. The blog is called “Using SACCR to Monitor Counterparty Credit Risk.”

I think what we need to look at when we’re talking about SACCR is not just what it has to be used for, I think we have to look at the fact that also this is a useful tool. The number one risk when you’re trading OTC bilateral derivatives, whilst it feels like it might be market risk, when you look at bank disclosures, the actual biggest size risk of banks is related to their credit risk weighted assets.

So even if you don’t have to use SACCR from a regulatory perspective, if you’re an end user, if you’re a buy side, still really important to monitor what your counterparty credit risk is versus your dealers. SACCR is very simple, very easy to implement very transparent. There are some great blogs out there which explain the model as well.

And so it’s really a natural thing to say, look, the regulators have now finally given us a risk sensitive model for counterparty credit risk. How can we use this in examples that are not actually regulatory mandated? When I published the blog in the same week, ISDA also published a thought leadership piece entitled “Hidden in Plain Sight.”

I had no idea that this ISDA piece was coming, but when you read the ISDA piece, it basically highlights one of the major potential uses of SACCR. What is to say is that, look, regulators now have huge amounts of data and in ISDA’s opinion, regulators should be doing more with this regulatory mandated data to monitor exposures in the market.

In my opinion, SACCR gives you exactly that tool. If you’re a regulator, if you’ve got budget to sit there, implement a SACCR-like monitoring tool to look at counterparty credit exposures in your jurisdiction. So it was a really nice tie-in for the blog to see that ISDA are looking at these potential uses as well.

I’m sure Amir has some questions about it because it is actually a blog that Amir asked me to write about, about a year ago. And we’ve had such a backlog of topics. We’ve only just got around to publishing it.

Amir Khwaja: It’s a great blog. So I think I enjoyed reading it. So I guess what I find interesting is that this move towards in Basel III towards standard, transparent methods in a way of forming internal models.

And clearly SACCR has been introduced as a flaw for counterparty greatest capital in the banking sector. But I really like a point about even non banks should be using that metric. And you don’t explain why, is that just because it’s standardized or what’s the value in, a hedge fund or an asset manager-like company using that for counterparty exposure?

Chris Barnes: If you think about a hedge fund or an asset manager, what they’re being paid to do is manage risk in terms of market risk. They should be concentrated on what are their market risk exposures? What is their alpha relative to their benchmark? They are not paid to manage counterparty credit risk. They are essentially considered as risk free trades from the perspective of the mandate, right?

So it’s a really prudent thing that if you’re trading any bilateral counterparty risk that you really closely monitor it. Now ISDA SIMM and the unclear margin rules, to be fair, have been a big step in the right direction of putting natural throttles on this risk anyway, right? You’ve got to collateralize it.

The leverage is reduced because you’ve got to post initial margin, even for bilateral trades. But don’t forget that physical effects, like all of physical effects is exempt from the unclaimed margin rules. And yet that could potentially, and typically is, one of the biggest drivers of your SACCR exposures facing a counterparty.

Now I’m not sat [sitting] here saying that portfolio managers should be looking every day, expecting their biggest dealers to default on FX trades. That simply won’t happen, but these are big, meaningful exposures, which historically to monitor, you would have to implement something like a historical VAR model to monitor what your exposures are.

Now we have a much, much simpler tool. That is still risk sensitive that has been calibrated by the Basel committee, so it has credibility. It also means that buy side are more symmetrical in terms of the way that they’re looking at their exposures with their dealer banks as well.

Amir Khwaja: Yeah, that makes sense, great point. And I think, so changing perspectives, there’s been quite a lot of press recently about the growth of private credit in the lending markets from the non bank sector. A lot of press, quite a lot of press about large banks complaining about increased cost of capital under Basel III, making it expensive in certain businesses.

So do you want to talk a bit about, is SACCR and the floor in SACCR driving business to private credit? Because those sort of firms do not have the same capital regulations, which obviously is not a good thing from a regulatory point of view or an oversight point of view.

Chris Barnes: Two things on that really.

One is that we’re using SACCR with a lens of, “you are managing market risk related to a derivatives portfolio.” We’re not saying you are also lending money here. And the big structural change we’ve seen in terms of private funds providing credit is that they’re stepping in to actually act as a lender.

Obviously, historically banks could then lean on their internal models, which to all intents and purposes for an outsider is a bit of a black box, to say we have this credit exposure here. We can offset that versus a market risk traded products, which has an offsetting credit exposure and the internal model will recognize that offset under SACCR.

Undoubtedly, those amounts of offset are reduced, which can potentially lead to higher capital requirements. It could be said that is a driver towards more private credit provision. It’s just difficult to say whether that’s due to SACCR specifically.

Amir Khwaja: Or to other reasons. So it might just be, it might just be business capacity, and non capital based reasons why there has been a growth in the non bank sector to provide private credit.

And I think to me, the key point, SACCR, transparency, simple implement, widely adopted, a floor for credit risk capital can be used by banks and non banks, and I think the more standardization we have, transparency, people understand the capacity.

Chris Barnes: Exactly. And almost as ISDA said, the regulatory community has provided us with SACCR the regulatory community would do well to apply SACCR to their own private data, which is admittedly at a trade level, but they have the counterparty information to build up a mapping of what the SACCR exposures are out there for that reported portion of the market.

Amir Khwaja: And I think, and the blogs you’ve written and the tools we have at Clarus, really help people understand how to implement SACCR for their portfolios, that’s great.

Chris Barnes: We typically start with a proof of concept on two or 3000 trades that runs with an Excel front end. Very simple, allows you to drill down, allows business users to understand the output, and then it’s scalable via our microservices.

Amir Khwaja: Great. Thanks, Chris.

Chris Barnes: Ali, I am done on SACCR for this week. I’m sure it won’t be long until there’s another podcast on SACCR from Clarus.

Ali Curi: Thank you, Chris. We appreciate your insight on SACCR as always.

And please share with us again the title of your blog post.

Chris Barnes: It is, “Using SACCR to Monitor Counterparty Credit Risk.”

Ali Curi: Great, that works. Chris, Amir. Thank you both for sharing your Quick Takes. Let’s do it again next week.

Amir Khwaja: Thanks, Ali, look forward to it.

Chris Barnes: Thanks.

Ali Curi: And that’s our episode for today. You can read more about these topics on the Clarus FT blog, and you can follow ION Markets on X and on LinkedIn.

Until next week, thank you for joining us.