06 October 2014

TABB Forum: Collateral Crisis? The Risks in CCPs and Central Clearing

With mandatory central clearing being worked through in Europe, there are, at the time of writing, 13 approved CCPs under EMIR. The move to mandatory clearing, while aimed at reducing systemic risk in the markets, will bring with it a whole host of additional risks.

Risk in central counterparty clearing houses (CCPs) is something that all market participants will need to be very aware of. As competitive entities, each CCP operates differently from the next, so it is crucial for market participants to carefully select, and subsequently monitor, each CCP with which they are involved. With other European directives such as UCITS V, depositary banks will need to monitor these financial market infrastructures closely, too. The financial world is changing rapidly, and with the change has come a shift in the way risk presents itself.

“One thing that is fashionable to talk about, but I do not think is talked about in the right way, is liquidity risk,” explains Mas Nakachi, CEO of OpenGamma. “Liquidity risk and credit risk are at opposite ends of the spectrum. If you work to reduce credit risk, you actually increase liquidity risk and vice versa. The focus on daily margining is a good thing from a credit risk perspective, but what people do not concentrate on is the impact to liquidity risk of doing that. It is the equivalent of having to pay your credit card bill every hour, rather than at the end of every month. That is the sort of impact we are looking at. What if you could also only pay your credit card bill in £20 notes? That is the sort of constraint you are talking about when only certain types of collateral are eligible.

The competitive element of CCPs is a risk in itself. “It is one of those very strange questions,” suggests Nakachi. “Some people would say that there are too many CCPs and that, even though it sounds counterintuitive, you would be better off with one CCP where you can net everything. For the dealers, there is a netting piece and there is a governance piece. As there are a lot of CCPs, these challenges add up. Theoretically, the ideal would be to have one or two CCPs globally and that would be it. That, of course, is never going to be the case. Some people view that as a failing of the CCP model.”

To add to the competitive element at CCPs, there is also something of a competition taking place amongst the global regulators responsible for implementing the clearing mandate in response to the 2009 G20 Summit in Pittsburgh where this idea was conceived. “There is no global regulatory harmonization,” asserts Nakachi. “Asia is always going to be different, as is Latin America and Europe. There are all these fractures in the regulatory space where risk can creep in. “We are introducing all kinds of new risk. This is not necessarily bad, but we need to be aware, from an industry perspective, of the risks in CCPs. For the next few years at least, we are going to be wading through these regulatory changes with a lot of unforeseen consequences.”

Full article on TabbForum (subscription required)

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