CFTC Market Risk Advisory Committee to Meet
Commentary by Bob Zwirb
The CFTC announced that the Market Risk Advisory Committee ("MRAC") will hold a public meeting on April 2, 2015.
The MRAC will discuss issues related to: (i) current risk management techniques employed by derivatives clearing organizations ("DCOs") to ensure that the appropriate measures are in place to address the potential default of a significant clearing member, and (ii) the evolving structure of the derivatives market, particularly with respect to swap execution facilities.
See: CFTC Press Release; 80 FR 13352.
Commentary
One issue that the MRAC will address, according to the meeting agenda, is whether the risk management techniques employed by DCOs are adequate to ensure their survival in the event of "a potential default of a significant clearing member." This duty arises from a core principle requirement for DCOs under CFTC Rule 39.11, which requires a DCO to maintain financial resources sufficient to enable it "to meet its financial obligations to its clearing members notwithstanding a default by the clearing member creating the largest financial exposure for the derivatives clearing organization in extreme but plausible market conditions."
For "systematically important" DCOs, the CFTC (CFTC Rule 39.29) requires financial resources to cover the default by the two largest clearing members. This is an important issue that goes to the heart of the Dodd-Frank revamp of the derivatives markets, but it appears that the committee may be defining the problem in too narrow a manner. A larger, and more significant, question that the Advisory Committee might want to consider is whether we are simply replacing a swap dealer oligopoly with an even narrower and more interconnected oligopoly of clearinghouses and their members. That is, to put it in the words of economist Craig Pirrong, are we creating "a derivatives marketplace dominated by a small number of CCPs each dominated by a small number of large bank clearing members who are members of major CCPs, which makes entire world clearing space concentrated and highly interconnected"? See, e.g., Streetwise Professor: "Hit the Road State Street."
If the goal of "financial reform" was to reduce such concentration and interconnections in swaps markets, should we be concerned that the clearing mandate may be obtaining the exact opposite result? And given that increased concentration of risk, are we in fact even worse off should one or two major clearing members come into financial difficulties?
What makes this potentially much worse is that the clearing houses may be willing to take on more risk than their members, but the members are very limited in their ability to back away from a clearing house since each clearing house may have a monopoly or near monopoly in any particular product.