20 September 2014

Gary Wright

Gary Wright - BISS Research

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Post-Trade Forum

The Post Trade Forum's aim is to propagate debate and discussion between senior practitioners in Post Trade Operations in the global securities market; to bring about increased awareness and knowledge across both buy-side and sell-side financial institutions in financial products and be a focal point for firms and practitioners to air views.

Who owns what in a CCP default

14 March 2012  |  2959 views  |  1

Clearing Houses are becoming even more important in the markets as regulatory and political change forces OTC into their systems and onto their balance sheets. Who knows if the balance sheets of Clearing Houses will be able to cope? We hope and expect that the regulators and the Treasury will make sure there is enough capital in place or at least available to mitigate this fear and risk. However should a Clearing House come down what mechanism is in place to determine who the beneficial owner of the asset is?

There has never been a CCP default and there are no precedents to follow to protect the beneficial owner unless they are being written. But are they? I haven’t found anyone in the industry to answer my question of beneficial ownership protection. We have certainly seen problems and delay with banks defaulting but a CCP default will be so much more cataclysmic in the market and could most certainly be contagious to markets and their participants. Even other CCPs could be badly affected and this calamity would keep squaring the risks creating a similar effect to a nuclear reactor overheating.

CCPs must have total and unequivocal protection if they are to fulfil their role and the needs of the market. Surely before OTC entry into Clearing Houses there has to be a transparent record of the financial condition of each Clearing House and a complete picture of how each CCP will operate to manage a default. This has to include how the beneficial owner can be assured that their assets are totally protected and that there will be no delay in them accessing their holding.

This might entail Clearing Houses and CCPs coming together to produce a standardised procedure in the case of a default. Or is this already included in the interoperability that we all hear about between some, but not all CCPs?

All this and more will be debated at the next Post Trade Forum debate on the 17th April at the London Stock Exchange

TagsDealing roomsRisk & regulation

Comments: (2)

Kathleen Tyson-Quah - Granularity Ltd - London | 15 March, 2012, 15:28

Cheers for this Gary. 

It's important to understand that cash and initial margin assets posted to a clearing house do not stay in the clearing house.  They are deposited in clearing house cash accounts with banks and asset accounts with custodians.  The cash then gets re-used by the bank holding the deposit, as with any deposit.  The securities assets may be subject to lending arrangements by the custodian. 

In the event that a clearing house came under stress and needed its cash and assets back, the clearing banks and custodians would have to raise the cash/assets to return them.  That means liquidity stress on the banks/custodians.  This is a non-trivial source of risk for the CCP in quickly meeting its obligations in the event of a default.

Naturally the CCP will pick very big and safe banks for custody of cash and assets (perhaps even a central bank).  Using commercial banks reinforces the scale bias and liquidity advantage of big banks - and that increasing scale bias reinforces moral hazard and TBTF bias in the system.

We are supposed to be safer once OTC derivatives are margined through CCPs, but the reality is that the security of CCP performance depends on the chain of banks and custodians the CCP relies on.  I don't see the regulation of CCPs addressing this issue yet, but it should be an element in scenario development for stress testing of CCPs by supervisors.  And how we ever counter scale bias created by more complex, global markets and regulation remains a continuing mystery.

A Finextra member | 15 March, 2012, 15:52

Thanks Kathleen, this is a real big worry for the markets but bigger i think for national treasuries and central banks. Do you know if there is any default plans of CCPs to be published and if they plan to test them?

I am looking forward to your presentation and participation in the Post Trade forum debate on these matters and more. I just get the feel that the regulators are creating a ticking bomb and once OTC is in will go atomic

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name

Gary Wright

job title

Analyst

company name

BISS Research

member since

2007

location

London

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