The European Association of CCP Clearing Houses (EACH) published today an EACH paper entitled "Carrots and sticks: How the skin in the game incentivises CCPs to perform robust risk management". This document is part of series of papers produced in the context of the Online Workshop on CCP Risk Management that EACH organised jointly with the Journal for Financial Market Infrastructures (JFMI) on Tuesday 13th October 2020.
The objective of the paper is to discuss the concept of skin-in-the-game (SIG), consider its purpose, compare it to the purpose of other default management resources available at CCP level as part of the CCP’s default waterfall, as well as explain why EACH is of the opinion that the current calibration of SIG as included in the European Market Infrastructure Regulation (EMIR) is adequate. Some of the main messages delivered are the following:
- Purpose of the SIG – The purpose of SIG is to ensure the CCP is incentivised to perform robust risk management and that an alignment between the CCP’s and clearing members’ interests is in place. With their own funds at risk immediately after the contributions of the defaulting clearing member are exhausted, CCPs are very strongly incentivised to exercise robust risk management to limit the impact on their own funds, thereby limiting the impact on non-defaulted members’ funds.
- SIG and default fund cannot be compared – Differently from the SIG, the default fund is meant to cover potential losses caused by clearing member defaults in scenarios beyond those included under the defined confidence interval covered by the initial margin (i.e. tail risk). It is therefore clear that the two concepts cannot be compared.
- Calibration of the SIG – The current calibration of the SIG, calculated in line with Art. 35 of the EMIR RTS 153/2013, is adequate. No quantitative analysis from public authorities (e.g. ESMA Stress Tests on CCPs; European Commission’s impact assessments) has suggested that the current calibration of the SIG of EU CCPs may not be appropriate. In addition, on average the SIG of EU and UK CCPs represents 160% of their total profits, meaning that if a CCP were to use its SIG it would lose almost 1.6 years of profits. At EACH we believe that this is a strong enough incentive for CCPs to perform robust risk management.
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