Regulatory responses to CCP-related risks
6 December 2015
(Extract from page 71 of BIS Quarterly Review, December 2015)
In recent years, regulatory efforts to address the risks connected to central clearing have proceeded along two main lines: (i) strengthening the resilience of CCPs; and (ii) strengthening banks' capital requirements in relation to their CCP exposures. Work to further strengthen resilience of CCPs and banks' CCP exposures is still ongoing.
Strengthening the resilience of CCPs
The regulatory approach to strengthening the resilience of individual CCPs reflects three features of central clearing.
The first is the critical role of sound risk management. This explains why regulation in recent years has increased the requirements for sound CCP risk management practices, namely through the Principles for Financial Market Infrastructures (PFMI) (CPSS-IOSCO (2012a)). The bar has been raised on how CCPs manage credit and liquidity risks - for example, by requiring CCPs that are exposed to particularly high risks (ie when operating in multiple jurisdictions or clearing complex products) to have financial resources to cover losses from the simultaneous default of at least the two largest participants. More demanding standards on transparency and the management of operational and general business risks have further strengthened CCPs (CPSS-IOSCO (2012b)).
The second feature that regulation has addressed is the importance of continuity in the provision of clearing services for systemic stability and - if this is not possible - of an orderly resolution of CCPs. Because even sound risk management may not prevent a CCP's default in extreme circumstances, emphasis has been placed on the need to develop robust recovery and resolution regimes for CCPs (CPSS-IOSCO (2012a), CPMI-IOSCO (2014), FSB (2014a)). The challenges in this respect are to define tools that take into account CCPs' specific characteristics (business model, liability structure) and to assess the extent to which tools that are already built into CCPs' risk management (eg bail-in tools) can also serve as recovery tools.
The third feature is the diversity of CCPs' organisational structures, functions and designs. Because of this, standard-setting bodies have introduced broad international principles rather than detailed quantitative requirements, supported by strong CCP governance and oversight arrangements, also at cross-border level. The CPMI and IOSCO are currently assessing the implementation of these standards across jurisdictions, such as the compliance and consistency outcomes of existing CCP stress testing, margin frameworks, prefunded loss absorption capacities and recovery planning.
Enhancing capitalisation of banks' exposures to CCPs
The bar has also been raised on how individual banks are required to cope with CCP-related risks. In particular, minimum capital requirements have been introduced - as part of the Basel III framework - to cover bank exposures to CCPs, which include both trade exposures and default fund contributions. The same items are included in the denominator of the Basel III leverage ratio. Liquidity commitments that banks provide to CCPs are included among the obligations that need to be covered by liquid assets through the Liquidity Coverage Ratio (LCR).
Margin requirements for OTC derivatives (BCBS-IOSCO (2015)) and minimum haircuts on securities financing transactions such as repos (FSB (2014b)) seek to introduce positive margins for non-centrally cleared transactions in order to create or to preserve incentives for the banks to shift to central clearing.
Together with the CPMI, IOSCO and the BCBS, the FSB is pursuing a coordinated work plan in four areas: (i) CCPs' resilience; (ii) CCPs' recovery; (iii) CCPs' resolution; and (iv) achieving a better understanding of the linkages between banks and CCPs. Banks' trade exposures to qualifying CCPs are risk-weighted by 2% (BCBS (2014a)). The latter also includes off-balance sheet items converted using the standardised risk-weight factors subject to a floor of 10%. To avoid double-counting of exposures, a clearing member's trade exposures to qualifying central counterparties associated with client-cleared derivatives transactions may be excluded when the clearing member does not guarantee the performance of a qualifying central counterparty (QCCP) to its clients (BCBS (2014b)).