Y
et more risk managers have been applying for #FutureRiskMinds and sharing their vision of the future. Read on for what Leïla Passas, Resolution Directorate, SBCE, thinks will be imperative over the years to come.
The growth of CCPs’ business at global level in recent years and the development of a new recovery and resolution framework stimulate the need for a review of the management of risks related to the participation in CCPs.
CCPs are organized in segments, each of which offer clearing services for a certain asset class and have their own default waterfall. This dedicated protection mechanism allows the CCP to manage the default of one or more clearing member(s) through the successive use of different resources (defaulting members’ margins and contributions to the default fund, CCP’s own resources, non-defaulting members’ contributions to the default fund), thus permitting a mutualisation of the portfolios’ liquidation’s cost. Although the default waterfall is designed to confine the losses into the relevant segment, the main risk lies, from the members’ standpoint, in the loss of their contribution to the default fund where the first layers of the default waterfall (or contributions of the defaulting members) are insufficient. Additionally, members face a potential loss in respect of their unfunded contribution to the default fund, due to the potential obligation to the refill such fund – which risk is not taken into account in the calculation of banks’ capital requirements.
In the near future, in parallel to the greater number of centrally cleared transactions and the concentration increasingly characterizing this market, I believe that the main challenge for the members will lie in the better understanding and consideration of such exposure through the definition of risk indicators reflecting the probability that the default waterfall’s different layers, in particular the default fund, will be depleted to absorb the losses at stake. When building such indicators, members should take into account several factors, such as the number of members participating in the segment, the quality of these members (which is correlated to the risk of default on the segment) or the key features of the portfolio to be liquidated (e.g. size and market conditions).
Nevertheless, the non-default losses scenarios envisaged in the last developments of the regulatory framework reveal the growing attention that should also be given to a risk management issue arising at the CCP level, lying in the fact that the CCP itself may be failing or likely to fail due to losses resulting from other-than-clearing activities, such as its investment policy, operational or legal risk. Although it was underestimated until recently, I believe that there are reasons to see this scenario as a credible one for the CCP to be faced with. Thus I consider it as the reason for the participants to shortly increase their thoughts on this risk of the CCP defaulting – even more since saving the CCP is not a resolution objective (see, e.g., FSB’s Guidance on Resolution of CCPs). Accordingly, participants face a two-fold challenge encompassing their risk exposure to the segment(s) they participate in and an individual risk assessment of the CCP(s), which also raise an issue in terms of concentration risk.
Finally, banks will be increasingly exposed to the systemic risk that CCPs will be source of, principally due to the increasing central clearing obligation resulting from the regulatory framework and because of the economies of scale characterising this concentrated market. Since CCPs have members in common, the risk of a systemic crisis could arise for instance with the default of a G-SIB being a member of several CCPs, but also with non-defaulting members having to contribute to different default waterfalls in several CCPs. In this respect, I believe that the members’ full understanding of their risk exposure to CCPs will also lie in their ability to identify upstream such interconnections.
Proactively shape your firm's risk culture and explore regulatory change >>