The Futures Industry Association (FIA) has released updated recommendations to improve clearinghouse risk management following recent market developments.
The developments in question are the placing of a member of Nasdaq Clearing’s Nordic market in default in September. The losses were sufficiently large to exceed the margin provided by the defaulter and the CCP’s own skin in the game and required the use of the commodities default fund. This was the first use of a default fund by a major CCP since a default on KRX, the South Korean exchange, in 2013.
FIA says the default has highlighted certain areas of CCP risk management that deserve further attention. Particular sources of concern are risk management of self-clearing members; whether given margin collected properly reflects concentration risk; whether the Margin Period of Risk properly reflects the volatility of given products; whether auction processes are effectively designed to minimize losses to the clearing system; whether CCPs have sufficient skin in the game to align incentives to minimise the risk of such defaults.
“FIA supports full transparency of default analyses from CCPs to enable the improvement of risk management going forward,” it says.
The updated paper builds on a 2015 paper that outlined 15 recommendations and reflects the perspective of clearing members, and addresses the risks that CCPs bring to clearing members, their clients, and the market generally. Specifically, the paper contains multiple recommendations around membership criteria and CCP governance of self-clearing members.
It also issues recommendations around margin adequacy (particularly in low-liquidity markets and in respect of concentration risk and correlation risk), regulatory oversight and the risk management of members by CCPs. Further guidance is provided on default management including design and testing and skin-in-the-game.
“These recommendations aim to improve the risk management of every clearinghouse globally,” says FIA president and CEO Walt Lukken. “Today’s white paper covers issues highlighted by recent developments such as membership criteria, auction process, concentration risk, skin-in-the-game, and margin adequacy among other recommendations. We look forward to engaging with CCPs globally to discuss these recommendations further.”