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Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition by Jon Gregory

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14.3 Funding Value Adjustment

14.3.1 The Need for FVA

Despite the increased use of collateral, a significant portion of OTC derivatives remain uncollateralised. This arises mainly due to the nature of the counterparties involved, such as corporates and sovereigns, without the liquidity and operational capacity to adhere to daily collateral calls. In such cases, an institution must consider the full impact of counterparty risk and funding of the transactions in question.

A counterparty not adhering to the posting of collateral (non-CSA counterparty) will create a funding requirement for an institution trading with them. This relates to the need for the institution to offset or hedge with other transactions under CSAs (this is explained in more detail below). For unilateral exposures, such as loans, this is a cost for the institution making the loan. For a one-way CSA, this is a cost for the collateral posting institution. For bilateral exposures (such as swaps) under two-way CSAs this can be both a cost and a benefit as the transaction(s) may have both positive and negative value. Transactions with large CVA (and DVA) components may have very significant funding components also. FVA, also known as LVA, is the metric used to quantify this. FVA accounts for funding costs and benefits above the relevant index not already accounted for through (OIS) valuation or other components such as DVA.

In addition, the hedging above is more complex with the relevant ratio not being one-to-one. ...

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