Risk USA: Few options to manage CCP exposure, says RBS chief credit officer

Senior executives at RBS have weighed up the bank's potential exposure to CCPs

Banks need to think about their growing exposure to central counterparties (CCPs) and consider what will happen in the event of a clearing house default, but there are no obvious options available to dealers to manage this risk, according to Lesley Jones, group chief credit officer at Royal Bank of Scotland (RBS).

That is the conclusion of analysis carried out at RBS, which has been discussed among the bank's business and risk heads.

"We laid out some scenarios and then talked about what the range of potential outcomes could be. The senior risk executive and business executive made it clear that what we wanted to do was look at what our exposures were compared to these scenarios, so we could decide whether the types of trading we were building out were types that we wanted to build out," said Jones, speaking at the Risk USA conference in New York yesterday.

But options to manage these exposures are limited, she added. "There have been no decisions, but the question I posed personally to the senior executive is: ‘At what point do we decide enough is enough? You have to decide where that is and what your options are.' The look on their faces told me they didn't think they had that many," she said.

"How do you articulate your risk appetite to a CCP? What choice do you have? Stop trading?" she added.

How do you articulate your risk appetite to a CCP? What choice do you have? Stop trading?

New regulations are forcing banks to clear all standardised over-the-counter swaps through CCPs, and the first mandatory clearing requirement for certain interest rate and credit derivatives products – covering swap dealers, major swap participants and so-called active funds – came into force in the US on March 11. This was rolled out to other counterparties in the US in two further phases, and Europe is widely expected to introduce its first clearing obligation next year – although there are growing signs that could slip into 2015.

The RBS analysis focused on the risk to the bank's default fund contributions at CCPs in a range of scenarios, including the possibility of multiple clearing member defaults. Candidly, Jones admitted to doubts about whether the outcome of the new rules is better or worse for CCP members than a model in which OTC derivatives exposure continues to be managed on a bilateral basis: in the new regime, the risk of loss is lower, but the severity is "infinitely higher" Jones said, because of the contagion effects among participants in a pool of mutualised exposure.

Regulators are determined to ensure guidelines are in place to ensure an orderly wind-down or resolution of any financial market infrastructure, and the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions published a consultation document on the topic in August.

However, the financial crisis showed banks need to consider the unthinkable, Jones added. "Nobody thought through the impact of many of the things that happened in 2008, and we owe it to ourselves to keep asking about the unthinkable."