OFR_2016_Financial-Stability-Report

eleased the results of an unprecedented market-wide stress test of CCPs.
Similar tests in the United States could boost confidence in U.S. CCPs.
New Disclosures Shed Light on Derivatives CCP Risks
Figure 47: How the Typical
Central Counterparty Default
How Waterfall the Works Typical CCP Default
Waterfall Works
Defaulting CM
CCP
Nondefaulting CM
Clearing member (CM)
defaults
1
2
3
4
5
Initial margin
Prepaid
guarantee funds
Skin in the game
Prepaid
guarantee funds
Assessments
Note: CCP stands for central counterparty.
Source: OFR analysis
Until recently, there have been little data available to the public to assess
the risks of derivatives CCPs. In 2016, new data shed light on these risks
(see BIS and IOSCO, 2015c). CCPs provide the data in accord with stanadards
set by international regulators on the Committee on Payments and
Market Infrastructures and the International Organization of Securities
Commissions (CPMI-IOSCO).
All major U.S.-registered derivatives clearing organizations and 25 of
32 major CCPs around the world have provided information under the new
reporting standards. Of the other seven, five European Union (EU) CCPs
have provided disclosures under European standards. Two of the CCPs have
not made public disclosures. Although supervisors and clearing members
still get confidential information, CCPs now publicly disclose quantitative
and qualitative information consistent with the CPMI-IOSCO standards.
Although the data have some weaknesses, these may be viewed in part as
typical of new reporting standards.
Default waterfalls. CCPs face credit risk in their exposure to the failure of a
clearing member. The new disclosures provide information on the resources
that make up each CCP’s default waterfall. The default waterfall is the protocol
for the order a CCP uses those resources to cover losses. It serves as a
buffer against failure if one or more clearing member defaults.
Although the sequence may vary among CCPs, a typical waterfall structure
works as shown in Figure 47. To cover losses after a clearing member
default, the CCP would first draw on the margin in the defaulter’s account.
If the defaulting clearing member’s amount of margin is not enough, the
CCP next draws on the defaulting member’s prepaid contribution to the
guarantee fund.
The next layer of loss absorption typically comes from the CCP’s equity,
sometimes called “skin in the game.” This equity represents the CCP’s own
prepaid contribution to the default waterfall. If that were used up, the losses
then would be covered mutually by drawing proportionally on the prepaid
contributions made by the nondefaulting clearing members to the guarantee
fund. If those prepaid funds are not sufficient, the CCP may call on
the clearing members for more resources, known as assessments. More steps
may be taken in cases where the losses exceed these resources.
The new quarterly disclosures show amounts held in each part of the
waterfall: required initial margin (by house and customer accounts), CCP
equity, prepaid default funds, and callable assessments on clearing members.
50 2016 | OFR Financial Stability Report