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OFR to Target CCP Risks in 2016

The US Office of Financial Research (OFR)
says a key focus of its work in 2016 will be in depth study of the inter-connectedness
of central clearing counterparties to identify risks in the market structure.

In its annual report to Congress, the OFR acknowledges
the benefits the CCP model brings to markets –
prices are typically updated more frequently and reliably than for
trades between two parties; CCPs have access to data on derivatives trades and
this data can give regulators a view into the operations of derivatives
markets; and CCPs can reduce the risk of counterparty default – but also says
that a CCP is, “a single point of vulnerability for failure and creates the
potential for propagation of risks, potentially offsetting the advantage”.

While observing that discussions
among international regulators have centred on the merits of standardising CCP
stress tests, the OFR says that standardisation could resolve testing
inconsistencies, “but might fail to account for the diversity of CCP products
and services”.

The US Financial Stability
Oversight Council (FSOC) has designated five US CCPs as systemically important:
CME Clearing, the Fixed Income Clearing Corp., ICE Clear Credit, the National
Securities Clearing Corp., and the Options Clearing Corp.

The OFR points out that
these five are connected with global systemically important banks (G-SIBs) that
serve as settlement banks and where CCPs and their members deposit funds. “US
G-SIBs are also clearing members of multiple CCPs,” the OFR states. “A G-SIB
default could cause a CCP default and possible strain multiple CCPs at once, a
scenario that current CCP stress tests may fail to capture.

“Some CCPs also have
connections to each other, for example, through “cross-margining” agreements by
which positions can be netted across CCPs to central counterparties overseas,
and to CCPs not designated as systemically important,” it continues. “A CFTC
rule requires (and an SEC proposed rule) would require CCPs to have
recovery-and-resolution plans for continuing services to market participants
even if they face losses, liquidity shortfalls, or other weaknesses. The SEC’s
proposed rule would add a layer of protection against the risks of a potential
CCP default by requiring CCPs to hold net liquid assets funded by equity to
cover potential losses.”

The OFR report also
refers to earlier research conducted by its staff which raised the importance
of CCPs sharing information, and states, “For the OFR, improving the quality of
data available for evaluating risks in CCP operations is critical. We are
following such a recommendation from our Financial Research Advisory Committee
and planning ways to improve the quality and scope of related data.”  Twitter @lamboPnL

Colin Lambert

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