ColVA: Collateral Valuation Adjustment#

Collateral Valuation Adjustment, or ColVA, is the adjustment for the value of the choices embedded in a collateral agreement. A Credit Support Annex (CSA) often does not specify a single currency or asset for the collateral. Instead it lists several eligible types, and the party posting collateral chooses which one to deliver. That choice has a value, and ColVA captures it.

It also covers the difference between the rate paid on collateral and the risk-free rate that a plain valuation assumes.

Where the value comes from#

A plain valuation discounts the cash flows of a collateralised trade at the rate paid on the collateral, usually an overnight rate such as SOFR, SONIA or €STR for that currency. This is correct when the CSA names one currency of cash collateral and the collateral earns exactly that rate. Two things break the assumption:

  • Collateral rate: the rate paid on the collateral may differ from the discounting curve, for example because of a spread agreed in the CSA, or because there is a floor at zero on the interest paid.

  • Optionality: the CSA lets the poster choose between currencies or assets, which is known as a cheapest-to-deliver option.

Cheapest-to-deliver option#

Suppose the CSA allows collateral in USD, EUR or GBP cash. On each day the poster delivers the currency that is cheapest for them, that is, the one with the lowest interest rate or the one expected to weaken against the others. The poster holds a series of options, and the receiver has granted them. Over the life of the trade, the value of those options can be significant, particularly for long-dated trades and where the currencies have very different rates.

As the choice is repeated daily and depends on the future paths of several interest rate and FX curves, the value is path dependent and has to be simulated. The result is that the correct discount rate for the trade is not a single curve but the best of several.

Why ColVA matters#

The effect on a single trade is usually small, but it can add up:

  • on long-dated trades, as the optionality accumulates over many years

  • in currencies where the collateral rates differ widely, for example when one rate is near zero or negative and another is high

  • in the pricing of cross-currency basis, where the choice of collateral currency has a direct effect on the basis spread quoted

It also matters as a source of inconsistency. If one desk discounts at the rate of the contractual currency and another at the cheapest rate, the same trade can have two different values, and the difference is ColVA.

Relationship to the other adjustments#

ColVA is a funding-type adjustment and so it overlaps with FVA and MVA. It is separate from them because it comes from the contract terms and not from the firm’s own funding spread. A framework should say which effects are in the discount curve, which are in ColVA and which are in FVA.

When it is calculated#

Many firms do not calculate ColVA as a separate adjustment. Common treatments are:

  • build the optionality into the discount curve for the collateral, often called an OIS curve with a cheapest-to-deliver adjustment

  • calculate ColVA only for CSAs with a material multi-currency option

  • treat it as part of the funding or the model reserve, where the effect is small

A valuation control view#

  • CSA data: the eligible collateral, the currencies, the thresholds and the interest terms must be correct in the trade and agreement data. Errors here change the discount curve used for the whole netting set.

  • Curves: the collateral curves and the cross-currency basis are often illiquid at long tenors, so the inputs need independent price verification.

  • Methodology: where the optionality is modelled, the model should be validated and its limitations understood. Where it is ignored, the materiality should be assessed periodically.