Conduct risk, CCP defaults and bitcoin futures

The week on, January 27-February 2, 2018

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Banks wrestle with conduct risk capital add-ons

Conduct risk-related additions to Pillar 2 capital raise questions over scope of UK’s Senior Managers Regime

CCPs should pay twice into default waterfall, say researchers

Chicago Fed paper calls for contributions in two phases: before members’ capital is tapped and after it is depleted

Exchanges defend self-certification at CFTC meeting

Listing of bitcoin futures has led to calls for more transparency on new contracts


COMMENTARY: Reining in the exchanges

Bitcoin continues to create a good deal of lively news-flow. January saw the launch of bitcoin futures by the Chicago Mercantile Exchange and the CBOE Futures Exchange (CFE). It also saw the price of the underlying plunge from a high of $16,815 in early January to $8,300 on February 2. The launch of the futures contracts was surrounded by controversy, and not just because of bitcoin’s infamous volatility; critics also pointed out that the contracts were based on prices at only a few bitcoin exchanges, which are largely unregulated and open to possible manipulation.

Those critics haven’t gone away, and they have been joined by many leading futures commission merchants (FCMs). Before the contracts were launched, the FCMs were making their concerns public; both exchanges had set high initial margin rates for the contracts – 27% at the CME and 33% at the CFE – and raised them even further before launch to 47% and 44% respectively. Many FCMs believed even this was too low, and introduced their own top-up margin requirements for their customers. They now argue the process through which the contracts were approved for trading – self-certification – was rushed through by two exchanges desperate to match each other, and that it left the clearing members taking risks  they had never been given the chance to discuss.

The exchanges pushed back, saying a formal process of allowing FCMs to comment on new contracts before they are approved would be an unnecessary industry burden. Regulators seem divided on the issue, but it is possible bitcoin could be the trigger for an overhaul of how risks are handled at for-profit central counterparties (CCPs).

Most CCPs currently follow the same sequence of payments after a member default – known as a default waterfall. The defaulting member’s margin payments and contribution to the shared default fund go first. Next, the CCP itself pays out a tranche – its ‘skin in the game’, intended to provide it with an incentive for cautious risk management – and then the other clearing members’ parts of the default fund are paid out. If all that isn’t enough, the CCP can levy additional contributions from its members.

But the size of a CCP’s contribution varies greatly among CCPs. Recent research even suggests two tranches rather than one might be preferable. Gauging the correct size of CCP contribution is far from easy. Too small, and it has no incentive to improve its risk management, as the clearing members will absorb most of any loss (this is the situation some members say applies to the bitcoin futures at CME and CFE). Too large and the cost of capital will make fees prohibitive, and the incentive for clearing members to help take on portfolios to reduce the impact of a default will be lessened.



A task force convened by the European Systemic Risk Board has found eurozone banks hold only 17% of eurozone sovereign bonds and just 11% of the area’s supranational issuance. Philip Lane, chair of the task force, noted supranationals are favoured heavily by non-eurozone investors, who do not necessarily have the expertise to analyse individual sovereign creditworthiness, and they might be attracted to sovereign bond-backed securities for similar reasons. Hence, he concluded, overall demand for the senior tranche did not depend on prudential reform.



“I think there could almost be a benefit in there being no clear direction from politicians in the scenario that [Brexit] transition fails, because at that point you could have regulators step in and do what they want” – Risk manager at a large UK bank

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