European regulators have deemed the region’s clearing houses well placed to withstand potential defaults of their biggest members and other market shocks, after conducting the first market-wide stress tests of the increasingly important institutions.
On April 29, the European Securities and Markets Authority published the results of tests it undertook in 2015 on 17 EU-based clearing houses – which collectively held over €150 billion worth of collateral assets – designed to test their resiliency.
Esma found that the resources held by the bodies were sufficient to cover losses resulting from various scenarios including the default of the two largest clearing members.
Steven Maijoor, Esma’s chairman, said that the tests showed European clearers are “overall well equipped to face the counterparty risk associated with the considered stress scenarios”.
Clearers, which are also known as central counterparties, or CCPs, have been handed an enhanced role as shock absorbers in the post-crash financial system. But there are fears they represent a possible central failure point that could require large government bailouts if defaults piled up.
Financial News reported on April 25 that the Bank of England, the regulator of UK-based clearing houses, had asked the institutions it oversees to produce contingency plans to ensure they were prepared were the UK to vote to leave the EU in June.
Esma said it undertook its stress tests based on 2014 exposures, and included entities operated by the London Stock Exchange, Intercontinental Exchange and Deutsche Börse.
It considered extreme market shocks and three specific scenarios: the first was the default of each clearer’s two largest members; the second was the default of the largest two clearing members EU-wide; and the final scenario considered the default of the two clearing members with the largest aggregate exposures to EU CCPs weighted by their probability of default.
When a clearing house member defaults, its share of the clearing house’s default fund is generally used first to prop up the clearer, along with the initial margin it posts to collateralise its trades. The clearer’s own contribution is then tapped, and finally the wider default fund, if needed.
Thereafter, resolution schemes kick in to provide for uncovered losses and a CCP may be able to charge members with ensuring its financial survival through levying extra contributions.
Under the most severe scenarios, the Esma stress tests found that clearers faced small amounts of total uncovered losses that varied from €100 million up to €4 billion across all clearers.
Maijoor also issued recommendations to regulators that oversee clearing houses to ensure their resilience in the future.
These included asking clearers, when assessing the creditworthiness of members, to consider the potential losses a member may face due to their membership with other clearers. Esma also said that some clearing houses do not replicate the most extreme historic price changes observed as part of of their own stress-testing framework and encouraged regulators to ensure CCPs revised their price shocks used in their stress-test methodologies.
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