Buy side firms want
more transparency with regards to the risk profiles of central counterparties (CCPs),
according to representatives at a meeting hosted by the Commodity Futures
Trading Commission (CFTC) last week.
Speaking at the CFTC’s
Market Risk Advisory Committee (MRAC) meeting, Angela Patel, senior vice
president at Putnam Investments, contrasted the difference in counterparty
transparency for buy side firms before and after the advent of mandatory
She explained that
prior to the regulatory mandate issued to centrally clear certain derivatives
products as part of the G20 agreement, these transactions were executed subject
to ISDA and other support documents.
These stated the terms
under which each counterparty to the trade was protected and included details
such as credit rating requirements, funding requirements and valuation
These documents also
detailed the rights that came into effect in the case of counterpart
insolvency, meaning that firms had a clear view into the stability and risk
profile of counterparties that they were trading with.
Now, Patel argued, buy
side firms do not have the same level of visibility into their counterparties
in the centrally cleared trading model.
“With a cleared
contract asset managers no longer have a look into the stability and viability
of our counterparty. Factors we cannot see include the resources the CCP has
made available in the event of a loss scenario, the transparency into the
margin methodology employed and a detailed understanding of stress testing,
including the results,” she said.
Despite stating that
she views the implementation of central clearing as an overall positive for the
industry, Patel added: “Without a clean look into the resiliency of the CCP in
a stressed situation and an understanding of the tools available for CCP
recovery in the event of a member default and a clear resolution process should
the CCP itself fail, asset managers are left in a very real sense worse off than
we were before the regulation.”
Thum, a principal at Vanguard who was representing Sifma’s Asset Managers Group
(AMG) at the meeting, said that a lack of consistency, standardisation and
transparency in the clearing rules implemented by national regulators has made
it difficult for asset managers to compare CCPs across products and regimes.
Thum therefore called
for CPMI IOSCO to set minimum standards, rather than just principles, for risk
management, stress testing and financial safeguards of CCPs.
to address scenarios where risk from one CCP could cascade into other CCPs,” he
demanded. “Scenarios where risk from one clearing member could cascade across
multiple CCPs. Scenarios that take into account how many CCPs clear a given
product or asset class and how many clearing members each CCP has.
“In terms of
transparency, require the public reporting of stress test results against the
minimum standards and use the results to adjust required CCP total financial resources
to withstand financial distress,” he added.
global chief operating officer of risk and quantitative analysis group at
BlackRock, echoed Patel’s comments, stating that it is harder for BlackRock to
fulfill its fiduciary obligation to assess the credit worthiness of
counterparties with CCPs compared to bilateral counterparties.
Much of Walter’s
concern also centred around the potential use of buy side firms’ variation or
initial margin to plug a gap in CCP funds in the event of a clearing member
default that could leave taxpayers out of pocket – a concern voiced by a major
Australian asset manager at an ISDA conference in Sydney recently.
BlackRock represents real end-users of financial derivatives products, Walters said:
“When we talk about using variation margin or initial margin in the event of a
default, that’s kind of tantamount to placing a tax on end-users of products,
which we feel is very, very inappropriate.”
pointed out that if CCPs do apply variation margin haircuts in the case of a
default, whereby the CCP imposes a haircut on cumulative variation margin gains
on the portfolio of trades of each beneficial owner which have accumulated over
the days since the commencement of the default management process, then it is
likely to be end-users rather than financial institutions that lose money.
She pointed out that
the risk position of broker dealers is generally flat while the position of
BlackRock, as a representative of end-users, is by nature directional, leaving
them far more exposed to the application of variation margin gains haircuts.
“Just to clarify one
point that I do think has been lost in this debate is that the variation margin
primarily at risk of being haircut is the property of end-users. It is not a
pot of windfall gains that happens to be sitting at the CCP on any particular
day. Haircutting amounts to a random tax on market participants, particularly
those participants have been required by law to use the CCP service,” she said.
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