OFR_2016_Financial-Stability-Report

cause more-prudent CCPs to appear more precariously
positioned than less-prudent CCPs.
Regulators Conduct Stress Tests
Clearing members and regulators can use stress tests to
evaluate the vulnerability of CCPs and the potential systemic
impacts of a distressed CCP. Disclosure of stress
test results helps the public assess the resilience of CCPs.
Although stress tests use confidential data, publishing
the results of stress tests need not violate confidentiality.
In April 2016, European regulators published
results of the first market-wide stress test of European
CCPs (see ESMA, 2015). The tests used data from
the CCPs for three days in the fourth quarter of 2014.
The results included a description of the methodology
and “reverse stress tests.” The reverse tests described
the number of clearing member failures that would be
required to exhaust the prefunded amount and callable
resources of a CCP. The stress test focused on counterparty
credit risk. It did not consider liquidity, operational
risk, or reinvestment risk. The test identified
potential shortcomings. The report on the results also
made recommendations to national supervisors.
The stress test involved 17 CCPs in the EU that
clear securities or derivatives, including the European
subsidiaries of U.S.-based CME, ICE, and Nasdaq.
Together, the CCPs had more than 900 clearing members.
Thirteen consolidated financial firms belonged to
more than 10 CCPs.
The methodology differs from stress testing of large
banks in that it reflects the network effects between
CCPs and their clearing members. The network of
clearing members can be stressed only if two things
happen at the same time. First, common exposures
result in a sharp loss in value on broad classes of assets.
Second, at the same time, there is a failure of particular
clearing members whose credit risks had been mutualized
through the guarantee fund and callable obligations
to the CCPs.
In the EU stress test, 74 percent of default resources
among all 17 CCPs came from margin or collateral.
About 17 percent came from callable assessments on
clearing members, followed by 9 percent from paid-in
guarantee fund contributions, and 0.2 percent from
the CCPs’ own equity. These proportions suggest that
default waterfalls of EU CCPs are similar to those of
U.S. CCPs, based on the quantitative disclosures.
The stress test results also provided information
about concentration in CCPs. The test found that the
largest 10 clearing members accounted for 50 percent
of all the paid-in guarantee fund contributions in the
system. The report concluded that individual CCPs
face higher degrees of concentration than the system as
a whole.
The reverse stress test showed that the system could
absorb the largest 10 clearing member failures with no
shortfall in total resources and a €100 million ($112
million) shortfall in prefunded resources. A breach in
excess of €100 million would occur after the four largest
clearing members at each CCP failed.
The report also included a more severe stress scenario
in which every CCP’s two largest clearing members
failed at the same time. The severe test showed a
shortfall in prefunded resources. The shortfall reached
€10 billion ($11 billion), and then increased to €40
billion ($45 billion) when up to 10 clearing members
defaulted under other, harsher scenarios defined by
larger asset price movements and default frequencies.
The report concluded that even under extreme
stress scenarios, there would be no uncovered losses and
the maximum amount of assessments beyond the guarantee
fund would be €1.9 billion ($2.1 billion).
This first EU-wide stress test represents a clear
advance in assessing stability in financial market infrastructure.
Limitations, mentioned in the report, include
the small number of days during which the exposures
were measured and stressed, as well as the sole focus
on credit risk to the exclusion of liquidity, operational,
and other risks. The stress scenarios did not include the
dynamic effect of a change in market exposures from
increased market volatility that might precede the
failure of one or more large clearing members.
In November 2016, the CFTC published the results
of a joint stress test of the five largest CCPs registered
with the agency: CME Clearing, ICE Clear Credit,
56 2016 | OFR Financial Stability Report