Counterparty Risk Management - Best of times? Worst of times?

It was the best of times. It was the worst of times...Stealling a few classic lines out of Dickens' "A tale of two cities" is apropos for today's post - the new demand for counterparty credit risk management and collateralization. The best of times for counterparty credit risk? Not a surprise that the crisis has made all and sundry realize that highly rated counterparties such as Lehman Brothers can default, and in turn has push counterparty credit risk to the top of the agenda for risk managers and regulators alike. BCBS in particular is pushing for incremental risk capital charges for traded credit (including counterparty credit risk) and is increasing incentives for centralized counterparties and collateralization as a means to significantly reduce counterparty credit exposures. Nor are the regulators comfortable with banks' or the rating agencies ability to track counterparties PDs proactively. So naturally the focus on counterparty credit turns to exposures management through techniques like mark to market valuations plus addons or even potential future exposures. Although arguably more representative,the latter is a major computation challenge for many institutions requiring huge monte carlo simulations over long time periods. Not surprising therefore, that enterprise collateral management is the flavor of the month in counterparty credit risk circles.

But is it the worst of times? The same regulatory pressures have discouraged many from otc derivatives and securities borrowing/lending particularly in the developed world. In Asia by contrast, OTC derivatives do have the same stigma they have in the US and Europe.