BIS Reports on CCP-Bank Nexus during COVID-19 Pandemic
In a new staff report on the nexus between central counterparties ("CCPs") and clearing member banks, the Bank for International Settlements ("BIS") emphasized the need for central banks to evaluate the two entity types collectively.
In the report, the authors examined the actions of CCPs as a result of market instability caused by COVID-19 since mid-March 2020. They explained that, while CCPs issued large margin calls resulting in burdened liquidity positions of large dealer banks, the scope of the "procyclicality" - the tendency of variable fluctuation resulting from an economic trend - of leverage-embedded margin models is the effect of design choices that have relied on "a short period of historical price movements from tranquil times."
The authors recommended that, because individual institutions may take actions that appear prudent in isolation but are potentially straining to the security of the CCP-bank nexus, regulators and central banks should assess data from both banks and CCPs when evaluating margin trade-off.
Commentary
The BIS report raises an important issue of the recent market turmoil: is the increasing of CCP margin requirements at market stress moments (i.e., "procyclicality") a net positive for financial stability? BIS is not the first to emphasize this concern, but the recent market turmoil presents a new case study for consideration.
The authors note the impact of concentration in OTC derivatives clearing - only a handful of active CCPs (the largest CCP clearing 85% of interest rate derivatives) and the five largest clearing members accounting for more than 1/2 of the total positions at CCPs. The authors suggest that regulators and participants should further consider the trade-off in how margin requirements are set.