FSB asks whether CCPs could become shock-transmitters

Isda AGM: New analysis – due next month – looks at clearing network risks

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Regulators looking for cases in which clearing system might transmit – rather than absorb – shocks

The risks posed by central clearing to the wider financial system are the subject of new network analysis by the Financial Stability Board, which has produced “very interesting” results, according to FSB secretary-general, Svein Andresen. A summary of the findings is due to be published in June.

Mandatory central clearing of over-the-counter derivatives has led to a big jump in the amount of risk being handled by central counterparties (CCPs), all of which flows through a relatively small number of clearing members that act as intermediaries to thousands of derivatives users. Most of the time, this appears to be beneficial for financial stability, Andresen said, but it could also transmit stress more widely.

“Central clearing has generated increasingly important nodes in the system, whether CCPs or clearing members. When all of this works well, these are effective shock absorbers. But authorities need to know more about how shocks can travel through this system and affect the broader part of the financial system,” he said.

These interdependencies are the subject of the FSB’s analysis. Andresen was speaking at the annual meeting of the International Swaps and Derivatives Association on May 10.

In the short life of mandatory OTC clearing, the system has experienced few major tests, but volatility following the UK’s vote to quit the European Union last year showed how market moves could potentially have a knock-on effect on the world outside the clearing system; intraday margin calls by the big clearing houses in the two days following the vote are estimated to have totalled around $40 billion. Clearing members were able to meet those calls in the tight timeframe allowed, but some were shocked by the size of the payments and asked clients to help – with mixed results.

The episode left banks and regulators alike worrying about potentially systemic liquidity risks and the panic that might spread after a missed payment.

Earlier at the Isda meeting, banks and buy-side representatives had warned funding markets might not be reliable enough to support the derivatives market’s growing margin needs. Andresen did not specify what kind of dependencies the FSB analysis has considered.

Other researchers have also been looking for hidden fragility in the clearing system. In a technical paper published by Risk.net in January, four researchers sought to model credit and liquidity risks facing CCPs and their members, across a network of different venues. They found liquidity and funding risks were more significant than credit risk, but ultimately concluded clearing house membership is large and diverse enough to absorb losses without causing contagion to the rest of the financial system.

However, they also warned: “Any CCP-related losses are likely to be realised precisely under the extreme circumstances where members are least able to absorb them.”

Authorities need to know more about how shocks can travel through the clearing system and affect the broader part of the financial system
Svein Andresen, FSB

Separately, Andresen used his speech at the Isda meeting to offer some additional detail on the standard-setter’s plans for guidance on CCP resolution – the steps that would be followed by public authorities if losses overwhelmed a clearing house’s defences and management was not able to put the venue back on an even keel.

Final guidance will be issued in late June, Andresen said, alongside a companion document on CCP recovery – the rescue attempts that precede resolution – from the International Organization of Securities Commissions and the Committee on Payment and Market Infrastructures.

That may not be the end of it, however: “We will be undertaking further work on financial resources for CCP resolution and will determine by the end of 2018 whether the FSB should develop further guidance on this issue,” Andresen said.

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