On Wednesday 21 October, the World Federation of Exchanges (WFE) published a paper on CCP risk management, recovery and resolution. It highlighted:
- CCPs have a strong track record of managing market events – and noted they are best placed to manage distinct risks within specific markets
- The benefits of aligning incentives and interests of CCPs and clearing members
- CCPs shouldn't be subject to standardised “skin in the game” requirements
- It is vital that CCPs have flexibility in use of tools as they manage risk in dynamic markets
The WFE paper is the latest development in an ongoing debate about recovery and resolution and how CCPs should respond.
Nasdaq Clearing, the Europe-based multi-asset CCP, uses a senior tranche in its finance waterfall to complement the junior tranche. This acts as a buffer, providing an efficient tool to manage swings in volatility and, therefore, changes in the required capital levels.
This senior tranche has been in place since Nasdaq Clearing implemented its EMIR-compliant capital structure in 2012. As a result, the CCP’s current “skin in the game” is 12 percent – which is far higher than the reported industry average. “Skin in the game” refers to a CCP’s own contribution to the financial waterfall.
Fredrik EkstrÓ§m, President, Nasdaq Clearing comments: “Skin in the game is there to align the incentives of CCPs and clearing members, which is important. Flexibility is also crucial – and will need to extend to how CCPs work with each other because effective recovery is going to require greater collaboration.
“However, to get to the heart of the issue of systemic risk, we also need to address market structure. Pushing volumes towards one clearing house can have a cost advantage – by maximising netting and pooling collateral for a broad portfolio of trades. The problem is that aggregating trades in this way magnifies systemic risk. When there is so much reliance on one or two CCPs and something goes wrong, no recovery plan will able to solve the problem.
“A broad palette of CCPs offering a range of competitive clearing services in fungible OTC instruments has to be the preferred route. Firms can then achieve a balance between capital efficiencies, which is crucial, and a more robust and sustainable clearing infrastructure.”
