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Five Common Misperceptions About Credit Valuation Adjustments (CVAs) in Swap Valuations

Under ASC 820  fair value accounting rules, corporations must consider counterparty risk when reporting the value of a swap contract as either an asset or a liability. In some cases, this requirement is a non-issue because of mandatory central clearing, as required by the Dodd-Frank Act, which essentially eliminates most counterparty default risk by imposing certain risk-mitigation conditions such as margin/collateral requirements.
 
However, non-financial institutions that use swaps to hedge commercial risks are exempt from the central clearing mandate. Therefore, swaps entered by those entities are still subject to counterparty default risk for valuation purposes. 
 
In such cases, corporations cannot simply report, for example, the value shown on a quarterly statement issued by a bank counterparty. Often, a counterparty bank’s mark-to-market statement includes a clause indicating that the mark provided does not factor in profits, credit reserves, hedging, funding, liquidity, or any other cost or adjustment. Rather, a mark-to-market value of a swap is simply the net present value of all future cash flows calculated from the current swap curve. 
 
That mark, therefore, must be adjusted to incorporate an estimate of the counterparty default risk. That adjustment is accomplished by calculating a Credit Value Adjustments (CVA) for a given swap position. CVAs are mathematically complex and sometimes unintuitive in the gains or losses that stem from them. 
 
This article provides corporate accounting professionals with an overview of CVAs followed by five common misperceptions about them.
 
Download VRC’s latest special report for an in-depth discussion about the common misperceptions about credit valuation adjustments in swap valuations. 
 
For more information on the details of our modeling approach and how VRC can help you with the fair value reporting for swaps, contact VRC’s Complex Instrument Group practice leaders:
 
Tony Law, ASA | Managing Director
414-221-6217

Robert Barnett, CFA | Senior Vice President
415-513-4782
 
Article Author: Mu M. Liu, CQF, Senior Financial Analyst
312-957-7503