2012 Registration document and annual financial report - BNP Paribas

RISKS AND CAPITAL ADEQUACYCounterparty risk5COUNTERPARTY EXPOSURE VALUATIONThe Exposure at Default (EAD) for counterparty risk is measured usingan internal model and is subsequently incorporated into the credit riskweighting system. It is based on Monte-Carlo simulations which assessthe possible exposure movements. The stochastic processes used aresensitive to parameters including volatilities, correlations, and arecalibrated on historical market data. The potential future counterpartyrisk exposures are measured using an internal model (“ValRisk”) whichcan simulate thousands of potential market scenarios and does thevaluation of each counterparty trading portfolio at several points in thefuture (from 1 day to more than 30 years for the longest transactions).Value changes are calculated up to the maturity of transactions.When performing the exposure aggregation, the system takes intoaccount the legal contracts linked to each transaction and counterparty,such as netting and margin call agreements.Counterparty risk exposures are characterized by high variability overtime due to constant evolution of market parameters affecting theunderlying transaction value. It is therefore important to monitor notonly the current transaction values, but also to analyse their potentialchanges in the future.For non modelised counterparty risk exposures, the Exposure at Default(EAD) is based on market price evaluation (Net Present Value + Add On).SUPERVISION AND MONITORINGOF COUNTERPARTY RISKFuture potential exposures calculated by ValRisk are compared withthe limits assigned to each counterpart on a daily basis. In addition,ValRisk can simulate new transactions and measure their impact onthe counterparty portfolio. It is therefore an essential tool of the riskapproval process. The following Committees (sorted by ascendingauthority scale): Regional Credit Committee, Global Credit Committee,General Management Credit Committee, set the limits according to theirdelegation level.CREDIT VALUE ADJUSTMENTSON FINANCIAL INSTRUMENTS TRADEDOVER-THE-COUNTER (OTC)The valuation of financial OTC-trades carried out by BNP Paribas aspart of its trading activities (Fixed Income, Global Equity & CommodityDerivatives) includes credit value adjustments. A “Credit ValueAdjustment” (or CVA) is an adjustment of the trading portfolio valuationto take into account the counterparty risk. It reflects the expected lossin fair value on a counterparty exposure based on the potential positivevalue of the contract, the counterparty default probability, the creditquality migration, and the estimated recovery rate.DYNAMIC MANAGEMENTOF COUNTERPARTY RISKThe credit value adjustment is a variable of the existing exposuremovements and the credit risk level of the counterparty, which may belinked to the movements of the Credit Default Swaps (CDS) spread usedin the default probability calculation.In order to reduce the risk associated with the credit quality deterioratione mbedded in a financial operations portfolio, BNP Paribas may use adynamic hedging strategy, involving the purchase of market instrumentssuch as credit derivative instruments.Counterparty risk exposures on derivative instruments cover all derivativeportfolio exposures of BNP Paribas, all underlying and all combined poles.Fixed Income exposures represent the large majority of these exposures.The exposure on securities financing transactions and deferredsettlement transactions concern the Fixed Income business (primarilybonds), the Equity and Advisory business, primarily equity (stock lendingand borrowing) and BNP Paribas Securities Services (BP2S), both bondsand equity.52012 Registration document and annual financial report - BNP PARIBAS 283