central counterparts margin models, procyclicality and clearing members
by Anne Job de Lescazes CCP resiliency within COVID-19 crisis, a lesson learned from 2008 market crisis The UK HMT1 provides a clear and elegant definition of Central Counterparties (CCPs): “financial institutions which firms use to reduce risks that arise when trading with others on financial markets. They provide more certainty than specific types of financial contracts, including derivatives, will, if cleared through the CCP’s services, be honoured if one of the counterparties to a trade were to default.” In other words, CCPs are designed to bring down counterparty risk. They help to ensure that financial markets are both safer and more efficient. Following the financial crisis in 2007-08, where CCPs confirmed their essential role of market stability cornerstone, regulators, upon G20 request, extended the derivative contracts perimeter to be ‘cleared’ processed by a CCP (EMIR, Dodd-Frank Act). Parallelly, they published standardized principles to ensure that CCPs were well prepared and resourced to fulfil their increasing accountabilities (PFMI)2, complemented by numerous additional guidelines3. As a likely result of this worldwide effort to improve market resiliency against unavoidable crisis, CCPs, in particular European ones, remained resilient through the COVID-19 crisis, due to effective Business Continuity Plans and robust margin models. Additionally, further ESMA 3rd EU-wide CCP Stress tests did not reveal any systemic Risk concerns in either credit, liquidity, or concentration scenarios4.
margin procyclicality versus sensitivity: trade-off is still to be found A robust margin model is doubtless key for financial markets stability. However, increase of margin calls during Q1 2020, brought reflexion about margin models procyclicality to the center stage. The latter is officially defined as follows: “mutually reinforcing interactions between the financial and real sectors of the economy that tend to amplify business cycle fluctuations and cause or exacerbate financial instability”5.
Intelligent Risk - October 2021
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