BREXIT margin calls show limits of central clearing
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COMMENTARY: Wait for next time
Further investigation into the chaotic aftermath of the Brexit vote in June has thrown light on the stress it inflicted on central counterparties (CCPs) and their members. Last month, it emerged one clearing house in particular, LCH, had come under fire for making several extremely large margin calls in the wake of the vote. But it was not the only one – estimates of the total margin demanded by clearing houses on June 24, the day after the vote, range from $25 billion to more than $40 billion, in several calls for intra-day margin, each of which had to be met within an hour.
Since central clearing was first proposed as a remedy for the counterparty exposures that did so much to spread the 2008 crisis, industry observers have warned this simply substitutes liquidity risk for counterparty risk. CCPs are caught in a cleft stick: the more they try to protect themselves and their members by collecting additional margin as markets move, the more they increase the pressure on members already suffering from those markets.
In the event, every margin call was met without incident. But the truly worrying part is how few banks were involved – most of the volume in the cleared over-the-counter derivatives market goes through just a handful of banks. The failure of even one of these dominant players would be a truly shocking event. Yes, CCPs should be able to survive the default of their largest customer – even of their two largest customers. But if they were to impose 11-figure margin calls over a single day again – especially in a more long-lived and widespread crisis – would the consequences be limited to just two banks? "We survived that time" is not another way of saying "everything is fine and we should not worry".
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Under the US approach, a fine exceeding that amount would establish a new operational risk capital floor, meaning a $14 billion settlement would require the bank to hold an additional $3 billion of operational risk capital.
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