Entering 2020, most CCPs had bigger default funds than a year ago

Major central counterparties (CCPs) largely increased the size of their default funds over the year to end-2019.

Of the 22 default funds belonging to the ten large CCPs tracked by Risk Quantum, eight posted lower pre-funded amounts in their default funds year-on-year, while 14 reported larger amounts. 

The default fund covering Paris-based LCH SA’s €GCPlus tri-party repo service increased the most over 2019, by 57% to €225 million ($243 million). It is understood the service saw higher volumes at the latter end of last year. LCH SA and its London-based sister CCP LCH LTD also posted double-digit percentage increases in the size of the default funds reserved for fixed income products.


At the other end of the scale, Japan Securities Clearing Corporation’s JGB clearing fund dropped in size 41% to ¥344.9 billion.

Default funds act as a second line of defence for CCPs from imploding members. The first line is provided by members’ own initial margin (IM), the aggregate amount of which is generally many times larger than the default fund.

On average, default funds were 33% of the size of aggregate IM in Q4 2019. However, this masks a wide dispersion between clearing services.

For example, LCH LTD’s interest rate default fund was pre-funded to the tune of £6 billion, one of the largest among the group. But this amount was dwarfed by aggregate initial margin, which totalled £129.5 billion.

On the flipside, the Fixed Income Clearing Corporation and National Securities Clearing Corporation had default funds larger than aggregate IM. This is because of the unique way in which these services calculate default fund contributions. At these firms, member contributions act as their margin, instead of just as a payment to the respective clearing services.


What is it?

CCPs maintain default funds, often segregated by clearing service, to absorb losses in the event of a clearing member failure. They serve as a second line of defence to a clearing house after the defaulting member’s own initial and variation margin payments. The funds receive contributions from the clearing house and clearing members, and consist of pre-funded and committed resources.

For the calculation of default fund amounts above, only a CCP’s and its members’ pre-funded contributions (post-haircut) were counted. Several CCPs also disclosed amounts committed in their calculation of total default fund resources. These were excluded so as to compare only the resources the clearing services have immediately at hand

Disclosure standards drawn up by the Committee on Payments and Market Infrastructures and International Organization of Securities Commissions (CPMI-Iosco) oblige CCPs to break out the value of pre-funded default resources, excluding initial and retained variation margin, by asset type.

Why it matters

Default funds are expected to swell as CCPs take on more risk, as are the initial margin payments demanded from clearing members. Striking the right balance between the two, however, is tough.

Academics argue that the ratio of initial margin to default fund contributions matters, and that at a time of high systemic default risk – like today – strengthening the default fund should take priority. 

Last month, with the coronavirus crisis raging, Ronin Capital, a self-clearing member of CME and DTCC, defaulted – but the two clearing houses mopped up the losses without having to tap their respective default funds.

But with volatility at elevated levels across asset classes, it’s not improbable that a major CCP could witness multiple member collapses in the coming weeks that force it to drain its default fund. Then market participants and academics alike will be able to see whether these emergency resources were sized appropriately. 

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