8 June 2017
By Dennis McLaughlin, Nicholas Lincoln
In the paper “Stress This House,” LCH proposed a stress testing regime for central counterparties that would enable members to draw meaningful comparisons among CCPs, regardless of the variations due to product portfolio, margin models, confidence levels, default fund structure, assessments levels, etc. While there has been much discussion on this topic, it is fair to say that there has not been much agreement on how best to proceed.
The CPMI-IOSCO Quantitative Disclosure requirement is a good start on which to base the CCP comparison, but members have been continually asking for more detailed information.
In the experience of LCH, member concerns boil down to two basic questions:
The approach taken here to answering these questions is to leverage the fact that a CCP is required to meet the cover two standard, and that the stress scenarios implicit in the default fund sizing have been signed off by regulators. This means that a member knows that at least three clearing member defaults will have to occur simultaneously before the default fund contributions of non-defaulted clearing members will need replenishment and the CCP will need to make a further assessment.
The stress test report shows how the assessments grow (as a percentage of surviving member default fund contribution) as more and more members default. These are the maximum assessments, given a specified number of defaults, which would be called under the most adverse market scenario among all those scenarios that drive the default fund. At LCH, the ceiling on assessments is one assessment per default up to and including three defaults within six months.
The report also indicates the prevailing market stress scenarios that would drive these assessments, in answer to question two. Question one is also addressed since default fund contributions of non-defaulting members are at risk only after bilateral margins of the defaulting member(s) have been exhausted.
Perhaps the most surprising aspect of the information provided to members is that even after the simultaneous default of 10 member groups, there will only have been two assessments in the SwapClear default fund and less than a full assessment in the RepoClear default fund, under the most adverse stress scenario governing the default fund.
Each default fund listed is segregated by clearing service. This means that the collapse of any one clearing service will have no impact on the waterfall of the other four clearing services offered by LCH. This removes any misleading benefit driven by inadvertent correlations, as described in the "Stress This House" paper.
For each default fund in the CCP, the table sets out the following information:
1. Size of the Default Fund
2. Skin in the Game Loss
3. Remaining Non Defaulter Assessments
4. Scenario ID
5. Scenario Type
6. Scenario Description
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