CFTC MRAC Approves CCP Risk Management Recommendations (with Delta Strategy Group Summary)
Commentary by Bob Zwirb
The CFTC Market Risk Advisory Committee ("MRAC") approved final recommendations by the Central Counterparty Risk Management Subcommittee ("CRM") on how central counterparties ("CCPs") can enhance their efforts to prepare for the default of significant clearing members ("CMs"). Specifically, the CRM addressed issues and made recommendations that relate to default management implementation, auction process and porting. The CRM Subcommittee's final recommendations were approved by the full MRAC Committee by a vote of 19 to zero, with one abstention.
In a prepared statement, CFTC Chair Timothy Massad referred to a recent CFTC staff report, stating that the results of supervisory stress tests "show that clearinghouses had ample resources to withstand extremely stressful market scenarios on the test date." He concluded that the findings reveal that "risk was diversified across clearing members – a loss at one clearinghouse did not mean losses at all." Chair Massad noted that even though "[t]hese findings are good news," they reflect "only one test of default risk and the adequacy of the pre-funded resources on one specific date," which means they comprise a good "first step."
Other highlights of the CFTC MRAC hearing included:
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Chicago Mercantile Exchange Group Technology and Risk Global Operations President Kim Taylor agreed with the recommendation to standardize the terms used during the auction process, but warned that ex ante commitments to the exact process would be unwise, since circumstances vary. She stressed that guidelines are better than ex ante commitments.
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Some members called for relaxed anti-money laundering and know-your-customer protocols for non-defaulting CMs during times of stress, which would allow more efficient porting of customer positions and collateral from defaulting CMs. Members also asked for leniency concerning capital requirements.
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A question and answer discussion on the coordinated CCP default fire drill by the Bank of England with David Bailey, Director of Financial Market Infrastructure, Bank of England.
Delta Strategy Group prepared a summary of the CFTC MRAC hearing.
Commentary
The following sober passage appeared among key points in the CRM Subcommittee's report:
During periods of market stress, when CCP margin requirements increase, and when availability of bank capital may decline, portability will be more difficult as less capital is available to accept the cleared derivative portfolios from other clearing members. Without the ability to transfer client positions in an orderly manner, a CCP would be forced to liquidate the positions of clients of a failed or distressed clearing member, creating a strain on the market, market losses for clients, and losses of clients' hedge positions, which would increase risk in the real economy.
In short, the CFTC overlooked the real risks: clearinghouses might save themselves by demanding more margin and, in so doing, drain liquidity from the system. Such a demand would force the liquidation of positions, causing a downward spiral of prices. Thus, clearing corporations could always save themselves by throwing the real economy under the bus.
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