Podcast: Andrew Dickinson on CCPs’ defence mechanisms

Trades’ size limits, membership rules and more transparency key to avoid another CCP default

Mauro Cesa (left) and Andrew Dickinson

Photo: Monika Ghose

For this Quantcast, Risk.net spoke with Andrew Dickinson, who leads the CCP analytics group at Bank of America.

With Leif Andersen, global head of the quantitative strategies group, Dickinson developed a model to assess exposure to a central counterparty. Crucially, the model has the ability to capture wrong-way risk stemming from the presence of clearing members with outsized positions. Such positions can trigger the member’s default in the case of large, adverse market moves.

If the defaulting member has an unhedged position and is unable to meet the margin calls, the CCP’s default fund could suffer significant losses. The case of power trader Einar Aas’ default at Nasdaq Clearing in September 2018, and the default fund’s subsequent loss of $119.7 million, set alarm bells ringing for banks, CCPs and regulators.

“In our view, initial margin on its own is not a sufficient risk mitigant in isolation. It needs to be complemented by suitable controls in order to prevent members clearing outsized, unhedged positions,” says Dickinson.

The concerns of broker-dealers have been debated in meetings organised by the Futures Industry Association and the International Swaps and Derivatives Association. The message from the industry seems to be unanimous.

“We and our peers are suggesting there needs to be a strengthening of the regulation to either impose limits or stronger membership criteria, or at the very least have greater transparency,” says Dickinson, lamenting the scarcity of transparent information released at the time of Nasdaq’s default.

He explains how their previous model was extended to include a probability distribution, a Student-t, which allows for arbitrarily fat tails to model rare events. Its output is one easy-to-interpret figure that can provide precious information to all of the parties involved and help them decide how to deal with such circumstances.

Index

00:00 Intro

02:02 Central clearing vs bilateral clearing

05:05 One bad apple

07:10 What are the results in the paper?

09:40 Key components of the model

12:30 Wrong-way risk

17:00 How this model helps understanding of Einar Aas’ default at Nasdaq

19:15 What info does the model give you and how can you use it?

20:50 Who should decide to adopt this model?

23:15 Feedback from CCPs and regulators

26:20 Model’s further developments

To hear the full interview, listen in the player above, or download. Future podcasts in our Quantcast series will be uploaded to Risk.net. You can also visit the main page here to access all tracks, or go to the iTunes store or Google Podcasts to listen and subscribe.