Podcast
Questions and Answers
What is a potential risk associated with high switching costs for members in central clearing?
What is a potential risk associated with high switching costs for members in central clearing?
What legal risk may arise from netting with novation in cross-border scenarios?
What legal risk may arise from netting with novation in cross-border scenarios?
What infrastructure risk could occur due to the concentration of clearing activities?
What infrastructure risk could occur due to the concentration of clearing activities?
What is a common misconception regarding liquidity costs in clearing?
What is a common misconception regarding liquidity costs in clearing?
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What adverse effect can result from the misvaluation of eligibility requirements for clearing members?
What adverse effect can result from the misvaluation of eligibility requirements for clearing members?
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Which statement best describes moral hazard risk in the context of infrastructure management?
Which statement best describes moral hazard risk in the context of infrastructure management?
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What does governance and access risk entail in complex clearing infrastructures?
What does governance and access risk entail in complex clearing infrastructures?
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What can be a consequence of banks offloading liquid exposures to CCPs?
What can be a consequence of banks offloading liquid exposures to CCPs?
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What do the G20 Commitments emphasize regarding OTC derivatives?
What do the G20 Commitments emphasize regarding OTC derivatives?
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Which document primarily addresses the clearing obligation for OTC derivatives?
Which document primarily addresses the clearing obligation for OTC derivatives?
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What is a primary condition under which a CCP can deny access to a trader?
What is a primary condition under which a CCP can deny access to a trader?
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What is meant by 'open access' in relation to CCP organizational requirements?
What is meant by 'open access' in relation to CCP organizational requirements?
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Which factor does NOT contribute to liquidity fragmentation as defined under EMIR?
Which factor does NOT contribute to liquidity fragmentation as defined under EMIR?
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Which of the following is NOT considered a requirement for interoperability between CCPs?
Which of the following is NOT considered a requirement for interoperability between CCPs?
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What is a limitation regarding authorization and supervision in CCP organizational requirements?
What is a limitation regarding authorization and supervision in CCP organizational requirements?
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What is a key reason for the denial of access by a CCP based on operational risks?
What is a key reason for the denial of access by a CCP based on operational risks?
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Which aspect of margining is primarily facilitated under interoperability principles?
Which aspect of margining is primarily facilitated under interoperability principles?
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Under what circumstance can interoperability agreements be waived?
Under what circumstance can interoperability agreements be waived?
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What is a key characteristic of the CCP's investment policy regarding allowable instruments?
What is a key characteristic of the CCP's investment policy regarding allowable instruments?
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Which of the following is NOT a recognized risk mitigation technique for non-centrally cleared derivatives trades under EMIR?
Which of the following is NOT a recognized risk mitigation technique for non-centrally cleared derivatives trades under EMIR?
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Which type of risks does the CCP investment policy aim to minimize?
Which type of risks does the CCP investment policy aim to minimize?
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What is the requirement for initial margins as per BCBS/IOSCO?
What is the requirement for initial margins as per BCBS/IOSCO?
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What could be a potential consequence of regulations being inconsistent across jurisdictions?
What could be a potential consequence of regulations being inconsistent across jurisdictions?
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Which is NOT a requirement that applies to firms that are not subject to mandatory clearing?
Which is NOT a requirement that applies to firms that are not subject to mandatory clearing?
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Which of these is an exemption from the initial margin requirement?
Which of these is an exemption from the initial margin requirement?
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What is the significance of liquid collateral in relation to margin requirements?
What is the significance of liquid collateral in relation to margin requirements?
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What type of valuations shall NFC not report?
What type of valuations shall NFC not report?
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Under what conditions will ESMA respond within 20 working days?
Under what conditions will ESMA respond within 20 working days?
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Which of the following is NOT included in the criteria outlined in ESMA RTSs?
Which of the following is NOT included in the criteria outlined in ESMA RTSs?
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What type of reporting is included under art. 9 EMIR for Trade Repositories?
What type of reporting is included under art. 9 EMIR for Trade Repositories?
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What is the purpose of the Unique Product Identifier (UPI)?
What is the purpose of the Unique Product Identifier (UPI)?
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What must a report include according to art. 3 of Impl.Reg. 1247/2012?
What must a report include according to art. 3 of Impl.Reg. 1247/2012?
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What is a primary requirement for trade reporting regarding aggregated positions?
What is a primary requirement for trade reporting regarding aggregated positions?
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Which of the following is a governance arrangement expected for UPI?
Which of the following is a governance arrangement expected for UPI?
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What is a typical component of the initial margin (IM) in CCP loss-allocation?
What is a typical component of the initial margin (IM) in CCP loss-allocation?
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Which of the following is NOT listed as a recovery planning tool in the CCP Rulebook?
Which of the following is NOT listed as a recovery planning tool in the CCP Rulebook?
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How can cash calls contribute to a CCP's recovery?
How can cash calls contribute to a CCP's recovery?
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What does VMGH stand for in the context of CCP recovery?
What does VMGH stand for in the context of CCP recovery?
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When assessing a default fund contribution, which of the following aspects is critical?
When assessing a default fund contribution, which of the following aspects is critical?
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In case of default, which mechanism can a CCP employ to manage its resources?
In case of default, which mechanism can a CCP employ to manage its resources?
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What primary function does a default fund serve in a CCP?
What primary function does a default fund serve in a CCP?
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What does the use of assessment rights imply for a defaulting CM?
What does the use of assessment rights imply for a defaulting CM?
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Study Notes
Challenges of Central Counterparties (CCPs)
- High switching costs: Difficulty switching CCPs due to non-fungible collateral pools and lack of interoperability.
- Cross-border legal risks: Legal complexities related to netting and access to central bank liquidity across borders.
- Concentration and infrastructural risks: Potential risks associated with CCP outages.
- Liquidity costs: The need for highly liquid collateral for clearing can create liquidity challenges.
- Interoperability risk: CCPs may engage in a "race to the bottom" in risk management policies to attract trading volume.
- Adverse selection risks: Misjudging clearing members' eligibility and initial financial requirements can pose risks.
- Moral hazard risk: Potential for the CCP to undertake excessive risk if it does not have sufficient "skin in the game".
- Governance and access risk: Complex infrastructure can pose governance and access challenges.
- Tail risk: Shifting "most liquid exposures" from banks' balance sheets to CCPs can increase the tail risk remaining on banks' balance sheets.
Key Legislative Acts on Clearing of Derivatives
-
European Market Infrastructure Regulation (EMIR)
- Aim: Regulate OTC derivatives
- CRD IV: Prudential requirements for exposures to CCPs.
- BRRD: Regulation for recognition of National Resolution Authorities (NRAs).
- MiFIR: Non-discriminatory treatment and trade reporting.
- AMLD: Safeguards for central counterparties (CCPs) in relation to anti-money laundering (AML) frameworks.
- SFT: Equivalence of OTC derivative definition within the Securities Financing Transactions Regulation (SFT).
- EMIR REFIT: Amendments to EMIR aimed at refining clearing obligations, suspension of clearing obligations, reporting requirements, risk mitigation techniques for non-cleared derivatives, and trade repository regulations.
- EMIR 2.2 EC Proposal: Proposed amendments to ESMA regulations concerning the authorization of CCPs and the recognition of third-country CCPs.
- EMIR 3.0: Focuses on strengthening risk management tools for CCPs and reducing cyclical effects on margin requirements.
- Regulation (EU) 2021/23: Provides a framework for the recovery and resolution of CCPs.
G20 Commitments
- Focus on strengthening transparency, responsibility, capital requirements, and prevention of future financial crises.
- Pittsburgh Summit (2009): Aim to clear all standardized OTC derivatives through CCPs by the end of 2012.
Default Fund
-
Defaulting Members:
- Contribution to the default fund.
-
Non-defaulting members:
- No use of margins posted by non-defaulting members.
Organisational Requirements
-
Open Access:
- Non-discriminatory and transparent access to CCP services.
- Reverse Access: CCPs should have access to trading venues.
- Exceptions for liquidity fragmentation within a single venue, requiring interoperability.
- Denial of access can be based on:
- Excessive anticipated transaction volume.
- Operational risks and complexities.
- Significant undue risks.
-
Interoperability:
- Designed to allow traders to exchange derivatives across different CCPs and collateralize their positions using assets held in multiple collateral pools.
Other Organisational Requirements
-
Conduct of Business Rules:
- Ensuring clear and transparent rules to manage conflicts of interest.
-
Liquidity Risk Controls:
- Restricting the use of money market funds (MMFs) and time deposits as liquid instruments.
-
CCPs Investment Policy:
- Investments should be in high-quality liquid instruments:
- Government securities, central bank securities, multilateral development bank securities.
- Low market risk, volatility risk, and inflation risk.
- Freely transferable and in the required currency.
- Active outright and repo markets.
- Reliable information on prices.
- Investments should be in high-quality liquid instruments:
Risk Mitigation Techniques for Non-Centrally Cleared Derivatives
- Margins: Initial and variation margins to reduce counterparty credit risk.
- Timely confirmation: Prompt confirmation of trades for accuracy and transparency.
- Daily valuation: Daily marking-to-market of trades to reflect current valuations.
- Portfolio reconciliation: Regular reconciliation to ensure accurate accounting and reporting.
- Portfolio compression: Reducing the number of trades and outstanding contracts.
- Dispute resolution
Trade Repositories (TRs)
- Legal entity in the EU: Legally established in the EU.
- Passport and ESMA supervision: Authorized to operate across the EU and subject to supervision by the European Securities and Markets Authority (ESMA).
- Data Compatibility: Data must be compatible with MiFID, potentially becoming Approved Reporting Mechanisms (ARMs).
Reporting Obligation
- Transaction reporting: All transaction data must be cleared and reported to TRs.
- Trade reporting: Aggregated positions must be reported, with breakdowns by type of derivative and at least weekly updates.
Data Formats
- Standardised Code: Unique Product Identifier (UPI) to identify OTC derivatives for transparency and clarity.
- Legal Entity Identifier (LEI): Used to identify the involved parties.
Initial Margin (IM)
- IM should be segregated to protect against defaulting members.
- IM contributed by defaulting CMs will typically consist of cash.
-
Loss allocation across waterfall:
- ** Defaulting CM's contribution to default fund**
- Tranche of CCP's capital
- Default fund contributions of surviving CMs
- VMGH, Haircuts, Assessment rights, Auctions and tear-ups
- ** Service closure**
CCP Recovery Planning
- Recovery planning is outlined in the CCP Rulebook.
-
Resolution tools:
- Variation Margin Gains (VMGH)
- Haircuts
- Cash calls
- Auctions
- Tear-ups
- Service closure
-
Recovery planning beyond immediate resolution tool:
- CCP recovery and resolution plans should encompass additional measures to recover losses and protect the financial system.
- Portfolio or replacement of the insolvent member.
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Description
Explore the various challenges faced by Central Counterparties (CCPs) in the financial landscape. This quiz delves into issues such as high switching costs, cross-border legal risks, and concentration risks that affect the efficiency and stability of CCPs. Test your understanding of these critical concepts and their implications for market participants.
