Default auctions, Libor replacement and op risk capital

The week on, August 10–16, 2019


Clients demand access to CCP default auctions

“In a default, we are comfortable taking on risk and can move quickly,” says DRW’s Wilson

Splits emerge over ‘pre-cessation’ fallback triggers

CCPs say cleared swaps will move to new rates if Libor is no longer representative of markets

Uniform? Op risk capital rules go their own ways

Europe and Canada set to include historical losses in new standardised approach; Australia probably not


COMMENTARY: Paying to play

The trouble with a last-resort mechanism is that, by its nature, it doesn’t get tested too often. (To digress slightly, this is why the UK’s nuclear deterrent was controlled in the 1960s via the roadside assistance radio network of the Automobile Association; the AA’s radios were being constantly tested by calls from stranded drivers, and could therefore be relied on to work). But back to the topic at hand.

Central counterparties (CCPs) have a multi-layered system of fallback protections in the event of a customer default; admission criteria should keep out the riskiest members, initial and variation margin payments and the rest of the default waterfall insulate against losses, and defaults are handled by hedging and liquidation procedures, as well as, if necessary, by auctioning off the defaulted member’s positions, either in blocks or all at once.

So it’s a bit worrying that, when Nasdaq suffered a major member default last year, the auction process didn’t go as smoothly as it might have. The €114 million ($130.1 million) loss, insiders say, was crystallised when only four members took part in the auction, leading to criticisms of poor decision-making by the exchange and a general desire to take a closer look at the auction process. The result was a discussion paper from the International Association of Securities Commissions and the Committee on Payments and Market Infrastructures in June this year.

The paper’s suggestion that clients, as well as clearing members, should be allowed to participate in default auctions (already the case at some CCPs) has caused a stir this week; buy-side lobbying groups have voiced support, clearing member lobby groups are against. The arguments used are interesting: clients, the banks and brokers argue, should have to contribute to the CCP default fund if they want to participate in the auction. Getting in on the auction, this argument assumes, is a privilege that must be paid for.

First of all, based on Nasdaq’s experience, it doesn’t seem to be a privilege that clearing members are rushing to exercise. But second, and more importantly, it highlights a potentially important clash between private and collective incentives.

Collectively, clearing members should want a rapid and successful auction that yields the best possible price – after all, they could be on the hook for shortfalls through top-up contributions, and also face serious consequences if in the worst case the auction failure leads the CCP itself to fail.

Yet, individually, each member has an incentive to keep the auctions small and inefficient, in order to snap up the portfolios of defaulting members cheaply – even at the expense of their fellow clearing members and the CCP itself. Letting clients bid means that one of them might end up outbidding a clearing member for something it wants.

Resolving this conflict will be a matter for the CCPs and their regulators, and will not be an easy process. But it has to start with the acceptance that the conflict exists.



Data from 36 EU lenders shows an aggregate increase year-on-year in the values reported for seven of the 12 systemic risk indicators used by the Basel Committee to designate too-big-to-fail firms. Total exposures increased 2% to €25.5 trillion ($28.5 trillion). Intra-financial system assets and liabilities, two of the three interconnectedness indicators, climbed by 1.2% and 2.5% respectively, to €2.9 trillion and €3.3 trillion. EU banks increase systemic footprint



“This is something new, because there’s not been a market dynamic with people managing futures versus swaps before. It means people are using the market to manage their risk, putting risk on and taking risk off” – Andy Ross, CurveGlobal on open interest in short sterling futures falling by 34%.

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