Lecture 7

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Questions and Answers

What primarily ensures continuity of critical functions within a CCP during a crisis?

Ad-hoc liquidity injections from banks

A series of pre-funded tools (correct)

Emergency government funding

Private sector investments in the CCP

Which scenario would NOT trigger the resolution of a CCP?

Sustained profitability in cash flows (correct)

Inability to meet its financial commitments

Failure to maintain critical clearing services

Insufficient recovery measures under the EMIR waterfall

What is the effect of legal risks as a CCP approaches failure?

Increased liabilities without the ability to recover

Reduction in the necessity for liquidity reserves

Greater likelihood of adhering to pre-funded measures

Diminished capacity to deviate from the CCP Rulebook (correct)

Which condition is a prerequisite for a CCP to be regarded as 'failing or likely to fail'?

The CCP is unable to maintain critical clearing services Signup and view all the answers

What typically characterizes liquidity problems in a central clearing context?

Inability to convert financial resources into cash quickly Signup and view all the answers

Which of the following is NOT considered a type of collateral for initial and variation margin requirements under EMIR?

Equities from the clearing member’s group Signup and view all the answers

What is one of the requirements regarding financial instruments used as collateral under EMIR?

Issuer should have low credit risk Signup and view all the answers

Which statement about segregation of client assets under EMIR is correct?

Client assets must be recorded in separate accounts and not subject to loss from other accounts. Signup and view all the answers

Which component is included in the default waterfall according to EMIR?

Margins Signup and view all the answers

How must a commercial bank guarantee function under EMIR?

It must be irrevocable and honored on demand. Signup and view all the answers

What is the maximum collateral concentration limit from a single issuer or group under EMIR?

10% Signup and view all the answers

What is the minimum resilience requirement for a default fund under EMIR?

Must withstand the defaults of the top two clearing members. Signup and view all the answers

Which of the following is TRUE regarding haircuts in collateral requirements under EMIR?

Haircuts are subject to general requirements as per the specified regulations. Signup and view all the answers

What is a key requirement for a Central Counterparty (CCP) to operate under EMIR?

It must have at least three years of operation. Signup and view all the answers

Which of the following must be included in the governance arrangements of a CCP under EMIR?

Key areas must include risk management and compliance. Signup and view all the answers

What does EMIR stipulate about the capital requirements for CCPs?

CCPs must comply with the Settlement Finality Directive. Signup and view all the answers

How long must a CCP retain transaction records under EMIR?

At least 10 years. Signup and view all the answers

What type of money should be used for settlement whenever possible according to EMIR?

Central bank money. Signup and view all the answers

Which of the following is NOT a requirement for effective margin management under EMIR?

Financial resources must be evaluated at least quarterly. Signup and view all the answers

What is a critical aspect of the risk management policies required by EMIR for a CCP?

They must include sensitivity testing to evaluate risks. Signup and view all the answers

What is the maximum allowed downtime specified in a CCP's business continuity plan under EMIR?

There is no specified maximum downtime. Signup and view all the answers

What must CCPs include in their compliance policy under EMIR?

Procedures for remediating past compliance failures. Signup and view all the answers

Which of the following entities is responsible for supervising compliance with EMIR?

The competent authority as defined under EMIR. Signup and view all the answers

What is a primary characteristic of open access as defined under EMIR?

Non-discriminatory and transparent access Signup and view all the answers

Which factor can lead to denial of access by a CCP?

Anticipated transaction volume exceeding planned capacity Signup and view all the answers

What is NOT a requirement for interoperability as per EMIR?

Denial of access based on historical performance Signup and view all the answers

Which of the following is a condition under which liquidity fragmentation is avoided?

At least one CCP in common Signup and view all the answers

Which aspect is part of the organisational requirements for a CCP?

Governance arrangements and remuneration policies Signup and view all the answers

What could potentially be a significant operational risk in CCP management?

High turnover rate in human resources Signup and view all the answers

In terms of margin requirements under EMIR, what is one of the key purposes of requiring margins?

To cover potential future exposures from defaulting members Signup and view all the answers

What is a mandate for CCPs concerning capital and additional resources according to regulatory standards?

At least 50% of capital must be maintained as additional resources Signup and view all the answers

Which type of product poses a significant undue risk that could lead to denial of access by a CCP?

Newly developed financial products that haven't been cleared before Signup and view all the answers

What is the primary condition for outstanding trades executed before approval but after the bottom-up process begins?

They fall under the concept of 'frontloading'. Signup and view all the answers

Which of the following is a requirement for derivatives listed on regulated markets according to MiFIR?

All transactions must be cleared by a CCP. Signup and view all the answers

What is the minimum capital requirement for a Central Counterparty (CCP) to be considered 'adequately capitalised'?

At least €7.5 million. Signup and view all the answers

What does EMIR require regarding margin calculations for Central Counterparties?

Margins must cover losses from at least 99% of exposure movements. Signup and view all the answers

How frequently must a CCP ensure that it fully collateralises its exposures?

At least on a daily basis. Signup and view all the answers

Which of the following describes a potential consequence of overly conservative margin calculations?

Increased liquidity risk during multiple default events. Signup and view all the answers

Which of the following factors does ESMA NOT consider when identifying products suitable for clearing?

Agreement terms between counterparties. Signup and view all the answers

What is the timeframe allowed for a product to fall under clearing obligations after becoming eligible?

4 months. Signup and view all the answers

What is one of the key requirements related to capital and liquidity for a Central Counterparty according to the given content?

A requirement to cover operational wind-down expenses. Signup and view all the answers

What characteristic distinguishes a collateral requirement for CCPs?

It must consider multiple stress scenarios based on historical volatility. Signup and view all the answers

Study Notes

Collateral Requirements

Highly Liquid Collateral: Can be used for both initial and variation margins
- Cash: Currency must be manageable and used for clearing by the CCP
- Financial Instruments: Issuer must have low credit risk, with no legal obstacles for liquidation, and an active market with reliable price data
  - Must not be issued by the clearing member's group, the CCP's group, firms providing essential services to the CCP, or firms owning real estate
- Commercial Bank Guarantee: Must cover a segregated account known to the CCP, be irrevocable, and have no wrong-way risk
- Gold: Held in specific locations
- Central Bank Guarantees: Issued in the currency to which the CCP is exposed
Other Collateral Requirements:
- Segregation: Above clearing threshold, client assets are recorded in separate accounts, with no netting of positions across accounts and assets are not exposed to losses from other accounts
- Portability: Client assets and positions (direct and indirect) are increased by use of margins
- Haircuts: Subject to general requirements
- Concentration Limits: No more than 10% of the CCP collateral from a single issuer or guaranteed by the same institution or group
  - If more than 50% commercial guarantees, the limit can increase to 25%

Default Safeguards

Default Fund: Used for losses exceeding margins, and must be large enough to withstand the default of the top two clearing members and adverse market conditions over 30 years
Default Waterfall:
- Margins are used first
- Only a few examples of such arrangements exist internationally
- Limited to cash securities (not allowed for derivatives)
- CCP must have at least 3 years of operation and have adequate policies to identify and manage risks
- Must be approved by the national authority and notified to ESMA
Derivatives: Have not yet implemented default waterfalls

Other Organisational Requirements

Colleges: Supervise compliance with EMIR, defined by competent authority
- Relevant currency is determined by the end-of-day CCP open positions, with the top 3 currencies being the "most relevant"
Recordkeeping: Must use common formats, be accessible, and retained for at least 10 years
- Includes transactions, positions, and business records
Business Continuity and Disaster Recovery Plans: Must include maximum downtime and backup facilities
Authorisation and Recognition: National rules are currently applied, including involvement from the ESCB
- CCP must comply with the Settlement Finality Directive, and respond within 180 working days
- Third country CCPs must provide detailed information about their business and compliance with home country rules, as well as evidence of equivalence and supervisory arrangement agreements
Settlement in Central Bank Money: Recommended if possible
Other Organisational Requirements: Art. 26 of EMIR and ESMA's Organization Regulation (ORG) outline specific requirements
- Governance Arrangements: Board assumes responsibility for key areas such as risk management and compliance
- Risk Management Function: Must be established within the organization
- Compliance Policy and Procedures: Must be in place
- Remuneration Policies: Must comply with ESMA's requirements
- Reporting Lines: Must be established and documented
- Audits: Regular audits must be conducted
- Information Technology Systems: Strict requirements are in place
- Disclosure of Holdings: CCPs must disclose holdings similar to Investment Firms, and adhere to other requirements to verify changes in subsidiary status
Stress Testing: Must be conducted at least annually, with models evaluating risks for total and liquid financial resources
- Daily testing of financial resource coverage
Back Testing: Models for initial margins must be back-tested
Sensitivity Testing: Historical data about stressed conditions and hypothetical stressed should be used
Default Procedures: Must be disclosed, including information about default fund, defaulting members, CCP resources, and default fund for non-defaulting members

Other Requirements

Organisational Requirements: Open access, interoperability, authorisation and superivision, recordkeeping, remuneration policies, governance arrangements, and stress testing are all key requirements
Open Access: Non-discriminatory and transparent access is required, with exceptions made for liquidity fragmentation and the need for interoperability
- Interoperability can be waived in specific instances with approval from both parties and the authority
  - CCPs can deny access based on volume of transactions, risk and complexity, or significant undue risk
Interoperability: Cross-system execution and margining of transactions is required
- ESMA can identify products that can be potentially cleared, with specific requirements for standardisation, volume and liquidity testing, and accepted pricing information
- Once a product is under the obligation, the CCP must be ready to clear it within 4 months
- A public register for eligible products is required

Derivatives Listed on Regulated Markets, Multilateral Trading Facilities, and Organised Trading Facilities

Clearing Obligation: The operator of a regulated market must ensure all transactions in derivatives concluded on that market are cleared by a CCP

Prudential Requirements and Risk Management of a CCP

Capital and Liquidity: CCPs must be adequately capitalized, with a minimum of €7.5 million and capital requirements subject to EBA RTSs
- They must also have access to liquidity facilities after evaluation by the ESCB, respecting the ECB's independence
Margins: CCPs must have margins to cover at least 99% of exposure movements over a pre-determined time horizon, and ensure daily collateralization of any exposed risks
- Time horizons are typically the last 6 months or 6 months of the most stressed conditions in the past 30 years
- CCPs can modify these time horizons after stress tests
- Intra-day margin calls are enforced
Conservative Calculation: Margins must be conservative in calculation
- High margins can limit resources for multiple default events and hamper liquidity
- CCPs must regularly monitor and update margins to reflect current market conditions

CCP Recovery and Resolution

Value of CCP: CCPs rely on their network of clearing members
CCP 'Runs': Despite safe harbors, legal risks increase as a CCP gets closer to failure
- Pre-funding and commitment are critical
Liquidity Problem: Even with financially strong counterparties, liquidity problems can occur if resources cannot be converted into cash quickly enough.
Recovery and Resolution: This process aims to ensure continuity of critical functions, using pre-funded tools if necessary
- A CCP will only be placed in resolution if recovery measures prove insufficient, and its failure would threaten the public interest

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Description

This quiz covers the various collateral requirements necessary for clearing through Central Counterparties (CCPs). It includes details on both highly liquid collateral options such as cash, financial instruments, and guarantees, as well as segregation and other requisites for effective client asset management. Test your understanding of these critical components in financial operations.