CCP in Focus - CCP Risk Assessments

Did You Know?

CCPs will be taking on the burden of clearing much of the $633.58 trillion OTC derivatives market, widely blamed for exacerbating the post- 2007 global financial crises. This risk will be concentrated into a few CCPs,  and each CCP has its own way of operating, its own risk waterfall, within its regulatory and legal framework, placing greater systemic risk upon each one.

Overview

End users are being forced into mandatory clearing at CCPs. How do you assess if these infrastructure institutions are fit for purpose? In response to G20 and supplementary initiatives regarding mandatory clearing, Thomas Murray Data Services established an industry-driven central counterparty (CCP) risk assessment programme. The service supports global regulatory imperatives to assess and monitor CCPs as risk concentrating vehicles.

Thomas Murray Data Services has been performing risk assessments in the post-trade space for over 15 years and now we are working with  major CCPs to compile comprehensive risk assessments that will enable our clients to understand every risk before selecting a clearing house. How is your margin calculated? Where does it go? What is your full, potential liability? How can a CCP mitigate your risk?

Central clearing of OTC derivatives is well underway in the US with Phases I and II of the CFTC’s implementation having come into force.  The EU is behind in terms of implementation, but mandatory clearing is expected to enter into force in late 2014.

Issue

There is huge potential for systemic risk in CCPs, and the consequences of a CCP failure could  be very serious for you as a participant and the market at large. What happens to your collateral contribution in the event of a default? What happens to your open positions? If a major participant at the CCP goes into default, how quickly does your collateral come under threat?

All of these questions, and more, are hugely important in making a decision as to which CCP(s) best fit your needs. Clearing houses operate within a competitive environment, a risk in itself, so you have choice and it is imperative that you make the right choice. You want robustness and a risk waterfall, plus margining requirements that you are comfortable with.

There is a regulatory obligation upon clearing brokers to conduct due diligence of the CCPs that they work with. This needs to be conducted annually and can be an onerous and expensive task. There is also a commercial imperative to benchmark each CCP, including its membership – the CCP is mutualising risk, but who else is in the group?

Solution

The Thomas Murray Data Services CCP Risk Assessment looks to determine the extent to which the CCP manages your risk burden. Each assessment brings transparency to the industry for the benefit of users, and offers cost savings to regulated firms that are required to perform due diligence and risk assessments on CCPs.

CCPs become the buyer to every seller and the seller to every buyer. This requires the CCP to step into all eligible contracts, not just selected contracts. This process makes CCPs risk-concentration vehicles so that an assessment of their risk management techniques is of paramount importance. In such a situation, transparency is critical, as is the ability to compare one CCP against another where there is user choice. CCPs are often multi-jurisdictional. Their use for some products is mandatory, while for others it is optional. Ownership of CCPs varies, and this can lead to conflicting and diverse stakeholder interests. An independent assessment of CCP risk is therefore critical to the users of these entities.

CCP Risk Assessments Deliver:

Risk Assessment Reports

An in-depth structured risk assessment report, along with access to the underlying supporting database.

Surveillance

On-going newsflashes advising of changes that impact the assessment reports, with the assessments being updated in near real-time.

Global Coverage

26 reports are immediately available covering CCPs across 18 major markets.

Transparency Index

Index of the level of disclosure by each CCP and their engagement with external reviews.

Buy-Side and Regulatory Interest:

Thomas Murray Data Services has generated a great deal of interest from both the buy side and policy community internationally. Our conversations with regulators ensure our work maintains currency with the evolving regulatory thinking. These institutions include: Bank of England, European Central Bank, BIS, Basel Committee of Banking Supervisors, CPSS, Financial Stability Board, BaFin, IOSCO, FSA, PRC (New York Federal Reserve). Thomas Murray Data Services has presented this project to CCP12 meetings since its inception.

Benefits

Some touch points that have triggered interest in subscribing to the service include:

  • A level playing field with truly independent external assessment, using a single model across all CCPs.
  • Transparency on risk that will allow users to drive the flows on a basis other than just price.
  • Up-to-date analysis of interoperability and any risk issues resulting.
  • A better, deeper understanding of the risk models used, the availability of margin offsets and a common industry standard for classifying the risks globally.
  • The collateral crunch has highlighted how CCPs optimise collateral and how its treatment is increasingly important. An ability to compare CCPs is extremely useful.
  • The enormous funds being funnelled into CCPs will put their treasury operations under the spotlight. An objective assessment of the credit risk is required.
  • The liquidity management tools that CCPs have - credit lines, repos, central bank support etc.
  • Full-time equivalency savings – reducing the cost of regulation by wholesaling the solution rather than duplicating it within each regulated group.
  • Expanded coverage at a low cost. Client requests for CCP services in markets not currently covered would require expensive due diligence.

CCPs Assessment Reports Available

26 CCP Risk Assessments across 18 markets are currently available:

ASX Clear (Futures) Pty Ltd Australia
CDCC Canada
LCH.Clearnet SA France
Eurex Clearing AG Germany
Hong Kong Clearing Corporation (HKCC) Hong Kong
Hong Kong Securities Clearing Corp Ltd (HKSCC) Hong Kong
The Clearing Corporation of India Ltd (CCIL) India
Tel Aviv Stock Exchange Clearing House (TASECH) Israel
CC&G Italy
Japan Securities Clearing Corporation (JSCC) Japan
Korea Exchange (KRX) Korea
Asigna Mexico
Contrapartos Central de Valores (CCV) Mexico
The Central Depository (Pte) Limited (CDP) Singapore
SGX-DC Singapore
SAFCOM South Africa
MEFFCLEAR Spain
SIX x-clear Switzerland
SGX-DC Singapore
TAIFEX Taiwan
CME Clearing Europe United Kingdom
ICE Clear Europe United Kingdom
LCH.Clearnet Ltd United Kingdom
CME Clearing (CME) USA
ICE Clear Credit USA
ICE Clear U.S. USA
The Options Clearing Corporation (OCC) USA

Risk Methodology

The CCP Risk Assessments have been designed to provide an independent assessment of CCPs across a range of defined risks:

  • Counterparty Risk
  • Treasury and Liquidity Risk
  • Asset Safety Risk
  • Financial Risk
  • Operational Risk
  • Governance and Transparency Risk

All the data for each CCP is structured in a consistent way to enable users to compare one against the other. Whether it is CCP interoperability or the impact of individual segregation on the default fund waterfall, the risk assessment should provide users with a primary source of information.

RISK DEFINITIONS & EXPLANATION:

A standard risk model for all CCPs including the following risks and key information:

Counterparty Risk

One of the major roles of the CCP is to mitigate counterparty risk between the clearing members. It does this by ensuring that the margin models and default fund are sufficient to cover market movements in the event of stress and default. Clearing members are particularly keen to ensure that the margin and default models do not expose them to undue exposure while at the same time providing acceptable levels of risk mutualisation. The membership criteria (including credit checks), limitations on liability and waterfalls attached to the default fund are all drivers of counterparty risk. The collateral that a CCP accepts introduces credit risk that may compound the counterparty risk which the CCP is managing. This can be managed via concentration limits and risk assessed haircuts. The funds that a CCP places in the market will also incur credit risk.

Treasury and Liquidity Risk

Treasury: The CCP collects participants' margin and default funds and may invest these independently using its own commercial criteria. These funds can be significant and represent a large amount of collateral available to the financial sector. Clearing members (and their clients) who provide these funds, have a keen interest in knowing how they are invested on their behalf. A CCP can manage its market risk by ensuring that it has proper Treasury controls around the deposits and investments that it makes, employing appropriate limits and ensuring that the safekeeping arrangements are adequate. This is not the market risk embedded in a derivatives contract.

Liquidity: The CCP is obliged to repay margin monies as positions and risks in the market vary. It is required, therefore, to ensure that the assets it maintains are sufficiently liquid such that it can repay margins at short notice. It may achieve this by ensuring that its market investments are extremely liquid or in cases of market stress, that it has alternative credit lines to provide liquidity.

  • Funding Liquidity Risk - the risk that a bank will not be able to meet efficiently the expected and unexpected current and future cash flows and collateral needs without affecting either its daily operations or its financial condition.
  • Market Liquidity Risk - the risk that a bank cannot easily offset or eliminate a position at the prevailing market price because of inadequate market depth or market disruption.
    The benefits arising from netting and the compression ratios achieved by the CCP will impact the liquidity requirements of its clearing members.
Asset Safety Risk

Some of the margin arrangements provide for the collection of non-cash collateral that needs to be held in custody. Clearing members will want to ensure that they have title to the collateral in the event of a default by another member or in the event of a default by the CCP itself. Where the collateral is managed by a third party the CCP will want to ensure that the proper controls are in place by that organisation that protects the rights of the clearing members to the collateral.

Where the CCP accepts collateral it should ensure that title is appropriate and that any rehypothecation is properly controlled. If the CCP engages in stock lending it should manage the risk mismatch between borrowing and lending.

Financial Risk

The risk to the CCP's own financial condition, which arises from the CCP's contributions to the waterfall, losses arising from Market Risk, competitive pressures and ability to continue as a viable company. Basel III requires the CCP to contribute to the default fund, which in turn impacts the clearing member's capital requirement against its own contribution to the default fund.

The level of support from shareholders, clearing members and possibly governments will mitigate this risk.

Operational Risk

The risk that deficiencies in information systems or internal controls, human error or management failures will result in losses either to the CCP or its clearing members, leading to delays, losses, liquidity problems and in some cases systemic risk.

Includes the ability to process transactions efficiently, the level of STP (either internal or via third parties), the number of trading venues supported across the range of products and the level of client segregation.

This risk can be assessed in terms of the availability of the CCP's infrastructure and the level of service quality.

Governance and Transparency Risk

The risk that a clearing member may incur a loss arising from the CCP not acting according to good governance arrangements or not providing full and accurate information on its activities.

The rules, margining methodologies and investment policies of the CCP should be clear and transparent to the CCP's stakeholders. The role of the Board and any Committees constituted under the CCP's rules should be clearly laid out and the participants should be suitably qualified. All the stakeholders should be identified and represented in the governance of the CCP.

Intermediaries subscribing to the product can white label the CCP risk assessments for distribution to their end-clients. This provides an independent source of information to end-users who need to make a choice of CCP driven by the asset safety considerations on offer. Avoid duplication of effort producing CCP risk analysis with expensive on-site due diligence – Thomas Murray Data Services's white label solution provides an off-the-shelf solution including real-time updates and client specific email alerts.


If you would like to purchase this service, or find out more about it, please contact Derek Duggan at dduggan@ds.thomasmurray.com or telephone him on +44 (0) 20 8600 2300.

Tags: CCPCCP in Focus