FIA and ISDA published a primer on the issue of non-default losses (NDL) at clearinghouses. This paper looks at non-default losses (NDL) at central counterparties (CCPs) and covers who should pay for what types of these losses. The paper also discusses resolution tools for non-default losses and demonstrates the balance sheet impact of a simplified CCP for each of the tools used.
The guiding principle for allocating NDL should be who manages the risk. In line with this principle we propose for the allocation of NDL resulting from operational risks, general business risks, legal risks, cyber risks and fraud (or other internal ‘bad acts’), the CCP and its shareholder should bear almost all NDL, in particular, the entire NDL related to risks that are exclusively within their control. Such an allocation will incentive prudent risk management.
In some instances, clearing members and their clients may bear at least a portion of NDL related to custodial risks, settlement bank risks and investment risks. For NDL that a CCP bears itself, the CCP’s parent company and/or equity holders should bear the remaining losses if a CCP’s capital or other dedicated funding is insufficient.