Central Counterparties: Progress in recovery planning, credit risk management and liquidity risk management

Date: 05.06.2018

How resilient are Central Counterparties (CCPs) to financial crises? The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) addressed this question in summer 2016 (see expert article on the BaFin website dated 15 September 2016).

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They stated in their report at the time that the ten CCPs included in the survey had made important and meaningful progress in implementing the Principles for financial market infrastructures. They did, however, encounter several deficiencies and instances of incorrect implementation in the areas of recovery planning, credit risk management and liquidity risk management.

This prompted the CPMI and IOSCO to conduct a follow-up assessment. In it, they examined not only the ten Central Counterparties from the first assessment but also nine further CCPs. The CCPs had to answer a questionnaire for each of the three topics. The CPMI and IOSCO published the results in early May.

Definition:Central counterparties

Central counterparties (CCPs) are companies that act as intermediaries between buyers and sellers of financial products. This means that counterparty risk, which is the risk that either the buyer or seller defaults, is eliminated for the contracting parties and transferred to the CCP. Since 2012, European market participants have been obliged by the European Market Infrastructure Regulation (EMIR) to use a central counterparty for clearing over-the-counter (OTC) derivative contracts which belong to one of the derivative categories within the meaning of EMIR.

CCPs are financial market infrastructures, alongside trade repositories, central securities depositories, securities settlement systems and payment systems. Their collective purpose is to ensure that payments are settled efficiently and securely.

Recovery planning

According to the results of the follow-up assessment, all participants from the first assessment have amended their recovery plans during the past 18 months. Changes were made primarily to rules and procedures for allocating uncovered credit losses, restoring a matched book, covering identified liquidity shortfalls and replenishing financial resources after a clearing participant default. Two CCPs that had not yet prepared recovery plans in 2016 had now developed such plans. However, they could not demonstrate that they had completely implemented all requirements of the recovery plan in their respective rulebooks and the corresponding internal processes.

Furthermore, some findings from the first report still hold true:

  • Some CCPs employ only one capped tool to address uncovered credit losses. In some cases, however, this may be insufficient to comprehensively address all uncovered losses.
  • Although all CCPs have at least one tool for addressing liquidity shortfalls, the CPMI and IOSCO doubt that all of the tools selected are consistent with the standards in the Principles.
  • A small number of CCPs have not established sufficiently clear rules and procedures to withstand the default of a clearing member.
    The new participants also reported amendments to their recovery plans. These focused mainly on rules and procedures to address uncovered credit losses and restore a matched book.

At a glance:Principles for financial market infrastructures

The Principles for financial market infrastructures represent a global standard for the structure and function of central counterparties, trade repositories, central securities depositories, securities settlement systems and payment systems. The Principles cover all manner of sources of risk, including credit, liquidity, market and operational risks, and set out rules for default management strategies, transparency, access to financial market infrastructures and efficiency. The aim is to make financial market infrastructures more resilient to financial crises. The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) monitor the implementation of the Principles in all significant countries that have committed to the G20 reforms for improved financial stability.

Credit risk management

Some of the CCPs that were also assessed in 2016 reported they had taken steps in the last 18 months to strengthen their arrangements for maintaining sufficient financial resources. These steps included, for example, introducing or lowering early action thresholds to either inform decision-makers or call for additional resources from clearing members.

The new participants, too, reported steps to improve the procedures they used to maintain sufficient financial resources.

However, the CPMI and IOSCO identified some procedures at CCPs that in their view are not in line with the provisions of the Principles. For instance, the internal processes at some CCPs appear inadequate or too time-consuming to ensure continuity in financial cover.

Liquidity risk management

The Principles also require financial market infrastructures to maintain sufficient liquid resources to cover a wide range of possible stress scenarios. While the CCPs themselves report enhancements to their liquidity risk management, the report concludes that only limited progress has been made by the participants in the previous survey in developing liquidity-specific scenarios in their stress testing framework.

Some of these CCPs still do not include in their liquidity stress tests a sufficiently wide range of scenarios that take into account the material liquidity risk posed by entities failing to perform contractual services in cases where these entities are neither clearing members nor clients – for instance, settlement banks, nostro agents, custodian banks, liquidity providers and linked financial market infrastructures.

Task of national competent authorities

The report therefore concludes that although the participants in the previous survey have made important progress towards eliminating the identified deficiencies, some of them still seem to be facing difficulties in introducing and implementing specific provisions and standards of the Principles.

Therefore, the CPMI and IOSCO ask all national supervisory authorities to thoroughly investigate the concerns and to urge the supervised central counterparties to take the necessary steps to fully comply with the Principles. In this context, they refer in particular to the guidance on the resilience of central counterparties published in July 2017 and the revised Recovery Report . The standards set out in these documents should be applied and taken into account appropriately by the relevant CCPs when they optimise their practices.


Edip Acat
BaFin Division for the Supervision of Financial Market Infrastructures

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