The Current Exposure Method (CEM) is a regulatory framework for calculating potential future exposure (PFE) for derivative contracts, used by financial institutions to determine capital requirements. It provides a standardized approach to measuring credit risk stemming from derivatives by summing the current mark-to-market value of contracts with a positive value and an add-on amount for potential future changes.
Mechanism
Within a systems architecture, CEM implementation necessitates a sophisticated risk calculation engine that processes real-time and historical market data for all crypto derivative positions. This mechanism involves computing the replacement cost for each contract with positive value and then determining the “add-on” factor based on notional amounts and asset volatility, factoring in netting agreements. The system must aggregate these values to produce a total exposure figure, crucial for regulatory reporting and internal risk management.
Methodology
The methodology of CEM involves a prescriptive, rule-based approach to credit risk measurement, distinguishing it from more complex internal models. Institutions apply specific supervisory add-on factors that vary by asset class and remaining maturity, aiming for a standardized, conservative assessment of counterparty credit risk. This approach simplifies cross-institution comparison but may not fully capture the nuance of specific crypto market risks or netting set optimization strategies.
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