A real-life stress test for CCP margin

Thanks to standardised reporting, we can track how clearing houses’ risk profiles have changed over time

For the 10 clearing houses Risk Quantum follows, 2017 was an easy year. In the absence of volatility, the number of margin breaches dropped – that is, occasions when a member firm was not holding enough collateral to cover its risk – as did the size of the shortfalls.

The venues’ latest public disclosures cover the first quarter of this year, when US rates rose, equity markets whipsawed, and supposedly rock-solid correlations between stocks and bonds temporarily broke.

Naturally enough, margin shortfalls jumped in number and size. At the Options Clearing Corporation, there were 38 breaches in Q1, with an average size of $61.4 million – the highest since standardised disclosures were introduced in Q3, 2015. At CME Group, there were just two breaches, but the larger of those – at $47 million – was the biggest the clearer has reported since the start of the disclosure regime.

What’s more interesting is what a central counterparty does about it. One response would be to tweak margin models so clearing members have to pony up more collateral. Another would be to strengthen the CCP’s defences against a possible member collapse, by reinforcing its default fund.

This is just what the Japan Securities Clearing Corporation (JSCC) appears to have done in the first quarter of this year. Clearing members contribute to a clearing house’s default fund alongside the house itself, and so far in 2018 it appears as though JSCC has asked members to increase their contributions by ¥135.5 billion ($1.2 billion).

One Risk Quantum reader wrote to us with a list of reasons for a clearing house to hike the asking amount – among them a shift in members’ risk profiles of such an extent that the balance between margin and default fund contributions had to change to better protect the CCP.

But a third – perfectly valid – answer to a jump in volatility is to do nothing. Under Europe’s clearing house regime, CCPs are required to collect margin to cover over-the-counter derivatives exposure at a 99.5% confidence level; for other instruments it is 99%. Breaches are allowed to happen, but not too often.

In that respect, a burst of volatility is good – it is a chance to ensure margin models are in good working order.