Margin call breaches could drive clearinghouse scrutiny, says Fitch Ratings
22 July 2020 New York
Image: ESB Professional/Shutterstock
Central counterparties (CCPs) demonstrated resilience in their credit and liquidity profiles despite a spike in market volatility in Q1 and unprecedented operational disruptions driven by the coronavirus pandemic, Fitch Ratings says.
According to the US credit rating agency, in the first three months of the year, the number and aggregate value of margin breaches of CCPs increased 115 percent and 450 percent from the prior quarter, respectively, when intraday price movements exceeded initial margins posted by counterparties.
Meanwhile, the largest global CCPs reported their highest exposure levels in Q1 since disclosures began in Q4 2015.
Aggregate peak initial and variation margin calls on a single day, reported by a group of global CCPs, rose 182 percent from Q4 2019 to $223 billion in Q1.
Moreover, Fitch estimates that, relative to Q4 2019, up to $150 billion in additional margins were called by CCPs on a single day in March 2020.
The credit rating agency views the reported breaches as “manageable relative to CCPs variation margin frameworks, close-out procedures in the event of counterparty default, sizable guarantee funds and other available resources”.
Fitch says the increased share of centrally cleared operations, compared to the 2008 financial crisis, helped ensure orderly functioning of financial markets and preserved confidence of market participants.
However, amid the coronavirus turmoil, the disparity of margins increased which highlighted the risk of increased pro-cyclicality and interconnectedness of the markets, which could drive further regulatory scrutiny, Fitch notes.
Closer attention by regulators is expected, according to Fitch, given the extent and disparity of margin increases by CCP and reported breaches in early 2020.
For example, the OCC's peak daily margin increased 663 percent in 1Q relative to its average in 4Q 2015 to 4Q 2019, with the LCH increasing by a lesser, but still substantial, 253 percent.
Fitch Ratings notes that “while the individual peak amounts could have been reached on different trading days in the quarter, margins calls were likely clustered around a brief period in March, imposing increased liquidity requirements on clearing members amid the market stress”.
More concerning is the existence of “significant” concentration risk in CCPs, which was first highlighted by the European Securities and Markets Authority’s recent survey
of clearinghouses and has now been reiterated by Fitch.
The ratings agency notes that margins held at CCPs tend to be concentrated with the largest counterparties, particularly at U.S. derivatives clearinghouses, including CME and OCC, where top-10 clearing members account for over 75 percent of total exposure.
This included LCH Group, Banque Centrale de Compensation (LCH SA) and Intercontinental Exchange (ICE) - ICE Clear US, ICE Clear EU and ICE Clear Credit.
Most of the liquidity burden of the margin increases was borne by a handful of these large institutions that are clearing members at the CCPs.
The largest banks helped mitigate the effects of the economic fallout due to the global pandemic and supported the liquidity of most asset classes, according to Fitch Ratings.
Fitch concludes that the margin disparities were largely driven by differences in the various CCP models' assumptions, such as the time period selected to measure historical volatility or the look-back period, with shorter look-back periods likely to be more pro-cyclical.
Various solutions can be considered to limit pro-cyclicality, like mandating longer look-back periods, instituting margin floors, exhaustible pro-cyclicality buffers or limiting margin increases during stress.
Fitch believes consistent and more substantial anti-pro-cyclicality margin components would be positive for CCP credit profiles and systemic stability.
According to the US credit rating agency, in the first three months of the year, the number and aggregate value of margin breaches of CCPs increased 115 percent and 450 percent from the prior quarter, respectively, when intraday price movements exceeded initial margins posted by counterparties.
Meanwhile, the largest global CCPs reported their highest exposure levels in Q1 since disclosures began in Q4 2015.
Aggregate peak initial and variation margin calls on a single day, reported by a group of global CCPs, rose 182 percent from Q4 2019 to $223 billion in Q1.
Moreover, Fitch estimates that, relative to Q4 2019, up to $150 billion in additional margins were called by CCPs on a single day in March 2020.
The credit rating agency views the reported breaches as “manageable relative to CCPs variation margin frameworks, close-out procedures in the event of counterparty default, sizable guarantee funds and other available resources”.
Fitch says the increased share of centrally cleared operations, compared to the 2008 financial crisis, helped ensure orderly functioning of financial markets and preserved confidence of market participants.
However, amid the coronavirus turmoil, the disparity of margins increased which highlighted the risk of increased pro-cyclicality and interconnectedness of the markets, which could drive further regulatory scrutiny, Fitch notes.
Closer attention by regulators is expected, according to Fitch, given the extent and disparity of margin increases by CCP and reported breaches in early 2020.
For example, the OCC's peak daily margin increased 663 percent in 1Q relative to its average in 4Q 2015 to 4Q 2019, with the LCH increasing by a lesser, but still substantial, 253 percent.
Fitch Ratings notes that “while the individual peak amounts could have been reached on different trading days in the quarter, margins calls were likely clustered around a brief period in March, imposing increased liquidity requirements on clearing members amid the market stress”.
More concerning is the existence of “significant” concentration risk in CCPs, which was first highlighted by the European Securities and Markets Authority’s recent survey
of clearinghouses and has now been reiterated by Fitch.
The ratings agency notes that margins held at CCPs tend to be concentrated with the largest counterparties, particularly at U.S. derivatives clearinghouses, including CME and OCC, where top-10 clearing members account for over 75 percent of total exposure.
This included LCH Group, Banque Centrale de Compensation (LCH SA) and Intercontinental Exchange (ICE) - ICE Clear US, ICE Clear EU and ICE Clear Credit.
Most of the liquidity burden of the margin increases was borne by a handful of these large institutions that are clearing members at the CCPs.
The largest banks helped mitigate the effects of the economic fallout due to the global pandemic and supported the liquidity of most asset classes, according to Fitch Ratings.
Fitch concludes that the margin disparities were largely driven by differences in the various CCP models' assumptions, such as the time period selected to measure historical volatility or the look-back period, with shorter look-back periods likely to be more pro-cyclical.
Various solutions can be considered to limit pro-cyclicality, like mandating longer look-back periods, instituting margin floors, exhaustible pro-cyclicality buffers or limiting margin increases during stress.
Fitch believes consistent and more substantial anti-pro-cyclicality margin components would be positive for CCP credit profiles and systemic stability.
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