Société Générale / Risk report 2021 - Pillar 3 2020

7 COUNTERPARTY CREDIT RISK COUNTERPARTY CREDIT RISK MEASURES | SOCIETE GENERALE GROUP | PILLAR 3 - 2021 143 CAPITAL REQUIREMENT FOR CVA RISK The financial institutions are subject to the calculation of a capital requirement under the CVA, to cover its variation over ten days. The scope of counterparties is reduced to financial counterparties as defined in EMIR (European Market Infrastructure Regulation) or to certain Corporates that may use derivatives beyond certain thresholds and for purposes other than hedging. The CVA charge is computed by the Group using mainly the advanced method: the positive expected exposure to the counterparty is mainly p determined using the internal model described in section 7.3.1, which allows to estimate the future exposure profiles to a counterparty, taking into account counterparty credit risk mitigants; the capital charge is the sum of two elements: VaR on CVA and p Stressed VaR on CVA. The method chosen is similar to the one developed for the calculation of the market VaR (see Chapter 9 Market Risk ), and consists of an historical simulation of the change in the CVA due to fluctuations in the credit spreads observed on the counterparties, with a confidence interval of 99%. The calculation is made on the credit spreads variation observed, on the one hand, over a one-year rolling period (VaR on CVA), and, on the other hand, over a fixed one-year historical window corresponding to the period of greatest tension in terms of credit spreads (stressed VaR on CVA). The associated capital charge is equal to the sum of the two multiplied by a coefficient set by the regulator, specific to each bank. The positions not taken into account in the advanced method are subject to a capital charge determined through the standard method by applying a normative weighting factor to the product of the EAD (Exposure At Default) by a maturity calculated according to the rules defined by the CRR (Capital Requirement Regulation). Refer to the “Credit Valuation Adjustment (CVA)” capital requirements table in Section 7.4 for the decomposition of CVA-related RWA between advanced and standard methods. CVA RISK MANAGEMENT The management of this exposure and of this regulatory capital charge led the Bank to purchase hedging instruments such as Credit Default Swap (CDS) from large credit institutions on certain identified counterparties or on indices composed of identifiable counterparties. In addition to reducing credit risk, it decreases the variability of the CVA and the associated capital amounts resulting from fluctuations in counterparty credit spreads. UNFAVOURABLE 7.3.3 CORRELATION RISK (WRONGWAY RISK) Wrong-way risk is the risk of the Group’s exposure to a counterparty increasing significantly, combined with a simultaneous increase in the probability of the counterparty defaulting. There are two different cases: general wrong-way risk, where there is a correlation between certain p market conditions and the creditworthiness of the counterparty; specific wrong-way risk, where the amount of exposure is directly p related to the credit quality of the counterparty. The specific wrong-way risk is subject to dedicated regulatory capital requirements, through an add-on applied when calculating the capital requirements. The EEPE indicator for transactions identified as facing a specific wrong-way risk is reassessed based on the assumption of a default from the counterparty. This process leads to stricter capital requirements regarding counterparty credit risks on such transactions. The PFE (Potential Future Exposure) calculated in these specific risk situations is also increased, thereby limiting the exposure on such transactions, as there is no change in the risk limit framework. The general wrong way risk is controlled via a set of stress tests (single or multifactor stress tests) applied to transactions made with a given counterparty, based on scenarios common with the market stress tests. This set-up is based on: a quarterly analysis of stress tests on all counterparties (financial p institutions, corporates, sovereigns, hedge funds and proprietary trading groups) allowing to understand the most adverse scenarios related to a joint deterioration in the quality of counterparties and the associated positions; a multi-factor stress test monitoring on all counterparties, which p allows to holistically quantify the potential loss on market activities following market movements which could trigger a wave of defaults on these counterparties; a weekly monitoring of dedicated single-factor stress tests for hedge p fund counterparties and Proprietary Trading Groups, subject to limits at the counterparty level. This framework is supplemented by an adverse stress test that quantifies the potential loss on the principal and third-party activities (client clearing) in the event of market movements violent enough to trigger a wave of defaults on this type of counterparty.