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Outline what a valuation agent does.

FRM® Part II · Credit Risk Measurement and Management · Margin (Collateral) and Settlement · FRM2.CR.17.d

The idea

The valuation agent is the party, or a designated third party, responsible for calculating exposure under the underlying transactions and valuing the collateral already held. It also works out the credit support amount and issues the delivery or return demand to the counterparty by the notification time. In many standard CSAs the party making the demand acts as valuation agent, so in a two-way agreement each side performs the role when it calls. The agent does not hold the collateral, which is the custodian's job, and does not decide defaults. Because the agent is normally an interested party, the other side can dispute a calculation, and the agreement then sets a resolution process. Accurate trade data, consistent market data and valuation timing are what keep valuation agents from generating disputes. For the exam, link the role to calculating and calling.

Formulas

Value credited for collateral after a haircut

Collateral value = MV × (1 − h)

MV
the market value of the asset
h
the haircut, as a decimal

The valuation agent applies it to each non-cash asset before comparing collateral held with the requirement.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which function is performed by the valuation agent in a CSA?

  1. Calculating exposure and the credit support amount, and notifying the counterparty of any call - correct
  2. Setting the thresholds, haircuts and eligible assets for both parties each yearWhy not: These terms are negotiated and written into the agreement; the valuation agent only applies them.
  3. Holding the posted collateral in safekeeping on behalf of the secured party and the pledgorWhy not: This is the custodian's role, not the valuation agent's.
  4. Deciding whether a counterparty has defaulted and terminating the tradesWhy not: Default determination is a right of the non-defaulting party under the Master Agreement, not a valuation-agent task.

The valuation agent marks the portfolio and the collateral, applies the CSA terms and issues the call. Custody and default decisions sit elsewhere.

A harder one

In a two-way CSA in which the party making the demand acts as valuation agent, which statement is correct?

  1. A third-party custodian must calculate every call because the parties cannotWhy not: Confuses the custodian with the valuation agent; the parties normally calculate.
  2. The party that is out of the money calculates the call because it holds the liabilityWhy not: Reverses the roles: the secured party, which is in the money, makes the demand.
  3. Only the higher-rated party may act as valuation agent, and its figures are finalWhy not: No such rule exists, and the other party retains a right to dispute.
  4. The party in the money calculates and calls, and the other party can dispute the figure - correct

In a bilateral CSA each party plays the valuation-agent role when it is the one calling, and a disputed calculation follows the agreed resolution process.

The hardest tier

A valuation agent computes a call as follows. Exposure owed to the bank is USD 30.0 million; the pledgor's threshold is USD 5.0 million; the pledgor holds posted cash of USD 12.0 million and bonds with market value USD 11.0 million at a 10% haircut. The MTA is USD 1.0 million and delivery amounts are rounded up to the nearest USD 1.0 million. What call does the agent make?

  1. USD 3.0 millionWhy not: Rounds down rather than up.
  2. USD 2.0 millionWhy not: Values the bonds at full market value, with no haircut.
  3. USD 4.0 million - correct
  4. USD 3.1 millionWhy not: Omits the rounding step: delivery amounts are rounded up to the stated multiple.

Required = 30.0 - 5.0 = 25.0; collateral = 12.0 + 11.0 x 0.9 = 21.9; call = 3.1, above MTA; rounded up to the nearest 1.0 = USD 4.0 million.

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