SD-08.5 — Valuation Adjustments & Reserves

Business Domain: BD-08 Valuation & Pricing (Middle office) · Applies: BOTH

Purpose

Calculates and applies the adjustments that move a raw mark to the value the firm will actually report and hold — the difference between a model’s mid-price output and a prudent, exit-aware valuation. SD-08.5 covers the valuation adjustments — the XVA family — and the valuation reserves — bid-offer, model-uncertainty, concentration and liquidity. It exists because a mid-market model price overstates realisable value: it ignores the cost of credit, funding and capital on a derivative, the bid-offer spread a real exit crosses, and the uncertainty in the model itself. SD-08.5 does not produce the raw mark — SD-08.1, SD-08.2 and SD-08.3 do — and it is not the credit- or counterparty-risk measurement of BD-07; SD-08.5 turns that exposure into a valuation number.

Service Operations

• Calculate the XVA adjustments — the credit (CVA), debit (DVA), funding (FVA), margin (MVA) and capital (KVA) valuation adjustments on the derivative portfolio.
• Size bid-offer reserves — the adjustment from a mid-market mark to the bid or offer side a position would actually be unwound at.
• Size model-uncertainty reserves — reserves for the uncertainty in a model’s parameters and inputs, heaviest on Level 3 marks.
• Size concentration and liquidity reserves — adjustments for positions large relative to market depth, where the realisable exit price is below the screen price.
• Compute prudent-valuation additional value adjustments — for regulated firms, the AVAs of the EU prudent-valuation regime, the regulatory-capital deduction for valuation uncertainty.
• Apply and record the adjustments — apply the adjustments to the carrying valuation and record each one with its basis, so the path from model price to reported value is transparent.

Inputs and outputs

• Inputs: the raw valuations from SD-08.1, SD-08.2 and SD-08.3; counterparty-exposure and netting data from BD-07 (SD-07.2) and collateral balances from SD-11.4; market-depth and liquidity data; the reserve policy from SD-08.4.
• Outputs: the valuation adjustments and reserves, and the adjusted carrying valuations — recorded against Valuation (E-07), consumed by SD-12.9 Fund Accounting & NAV, SD-12.2 ABOR, BD-07 Investment Risk and the regulatory-capital reporting in BD-16 SD-16.3.

Entities

• Consumes: E-07 Valuation (any method — adjustments overlay the observable-price, mark-to-model and manager-mark / appraisal valuations alike), E-04 Holding / Position (book = ibor for the live holding being adjusted), and the counterparty-collateral entity DR-04 Margin & Collateral Balance; the SD-07.2 counterparty-exposure and netting data from BD-07; the SD-08.1 raw valuations; the SD-08.2 raw valuations; the SD-08.3 raw valuations; the SD-08.4 reserve policy; the SD-11.4 collateral balances.
• Owns: the valuation-adjustment and reserve components of E-07 Valuation. A discrete Valuation Adjustment entity — each adjustment recorded with its type, basis and amount — is an open extension.
• Open question: whether the valuation adjustments warrant their own entity rather than being components of E-07 — an XVA or reserve figure carries a calculation basis and a lineage a raw mark does not.

Standards

• The XVA framework — CVA under IFRS 13 and Basel; the FVA / MVA / KVA literature.
• The EU prudent-valuation regime — CRR Article 105 and the EBA RTS on additional value adjustments.
• IFRS 13’s exit-price principle, which the bid-offer and liquidity reserves operationalise.

Open extensions

• The XVA sub-model and the reserve taxonomy.
• The Valuation Adjustment entity — the open question above.
• The Service-Operation-level input/output contracts.