CCPs perform well during stressful periods, says OCC
11 January 2019 Chicago
Image: Shutterstock
Central counterparties (CCPs) like OCC have performed extraordinarily well during many stressful periods, including the financial crisis of 2008, according to Dale Michaels, OCC executive vice president, financial risk management.
In a recent blog post, Michaels explained that this is due to many clearinghouse innovations that have been put in place, including mark-to-mark settlements, initial margin models, and default management processes.
Michaels highlighted that CCPs have become more critical to the financial industry. He noted that at OCC, they look to have a broad clearing membership that includes all qualified participants, as they aim to have a large and diversified set of clearing members.
Discussing initial margin, he cited that CCPs initial margin models are distinct from one another to reflect differences in the products and their inherent risks.
According to Michaels, in determining appropriateness, CCPs cannot only look at one aspect of a margin model. Margin resources are the primary way CCPs mitigate credit risks, but margin models are not calibrated to cover 100 percent of risks.
He said: “CCP's utilise robust back-testing to assess the adequacy of its margin calibrations. For example, in the case of OCC's Q3 2018 Principles for Financial Market Infrastructures disclosure, which reflects the prior one-year period, there were 36 breaches out of 56,266 total back-testing observations, which represents 99.9 percent coverage.”
He added: “While the US regulatory minimum margin period of risk for exchange-traded derivatives is one day, OCC believes that given the default management experience, which would likely involve an auction process, two days is more reflective of the practical timeframe needed to close out a defaulting counterparty's accounts.”
Consequently, OCC has set the margin period of risk at two days for its exchange-traded derivatives products, Michaels revealed.
“In our view, it’s not about the minimum regulatory requirement, but rather about what is right for risk management.”
Meanwhile, many considerations CCPs consider in establishing initial margin also apply to stress testing, as CCPs size their clearing funds at appropriate levels.
Michaels commented: “Generally, CCPs look to bring many similar products into clearing fund and default waterfall to allow them to be risk managed together.”
“While a clearing member may not clear every product cleared by the CCP, we want to have broad participation in a CCP clearing fund rather than small siloed funds for single products.”
He added: “If there is no recourse to access to other financial resources for small siloed funds, a CCP default is more likely, which would obviously be much more damaging to the customer, clearing firms, and the entire financial system.”
In a recent blog post, Michaels explained that this is due to many clearinghouse innovations that have been put in place, including mark-to-mark settlements, initial margin models, and default management processes.
Michaels highlighted that CCPs have become more critical to the financial industry. He noted that at OCC, they look to have a broad clearing membership that includes all qualified participants, as they aim to have a large and diversified set of clearing members.
Discussing initial margin, he cited that CCPs initial margin models are distinct from one another to reflect differences in the products and their inherent risks.
According to Michaels, in determining appropriateness, CCPs cannot only look at one aspect of a margin model. Margin resources are the primary way CCPs mitigate credit risks, but margin models are not calibrated to cover 100 percent of risks.
He said: “CCP's utilise robust back-testing to assess the adequacy of its margin calibrations. For example, in the case of OCC's Q3 2018 Principles for Financial Market Infrastructures disclosure, which reflects the prior one-year period, there were 36 breaches out of 56,266 total back-testing observations, which represents 99.9 percent coverage.”
He added: “While the US regulatory minimum margin period of risk for exchange-traded derivatives is one day, OCC believes that given the default management experience, which would likely involve an auction process, two days is more reflective of the practical timeframe needed to close out a defaulting counterparty's accounts.”
Consequently, OCC has set the margin period of risk at two days for its exchange-traded derivatives products, Michaels revealed.
“In our view, it’s not about the minimum regulatory requirement, but rather about what is right for risk management.”
Meanwhile, many considerations CCPs consider in establishing initial margin also apply to stress testing, as CCPs size their clearing funds at appropriate levels.
Michaels commented: “Generally, CCPs look to bring many similar products into clearing fund and default waterfall to allow them to be risk managed together.”
“While a clearing member may not clear every product cleared by the CCP, we want to have broad participation in a CCP clearing fund rather than small siloed funds for single products.”
He added: “If there is no recourse to access to other financial resources for small siloed funds, a CCP default is more likely, which would obviously be much more damaging to the customer, clearing firms, and the entire financial system.”
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
