Central Counterparty (CCP) Clearing Risk Assessments

Thomas Murray IDS has entered into an arrangement with Thomas Murray Data Services - the market leader in the provision of specialist market and ratings information to the securities services industry - to provide specialist data and ratings to the investor community. The following ratings and information products can be made available to investors:

Central Counterparty (CCP) Clearing Risk Assessments: Structured against a set of market defined risks, the CCP Risk Assessments evaluate the related risks of CCPs associated with counterparty, asset safety, liquidity, financial, operational and transparency and governance. Current coverage of 30 CCPs globally.

Background

In 2009 in the Pittsburgh Declaration, G20 countries changed the nature of clearing, the essential first step in post-trade transaction processing. In cash equity markets, trades were historically matched and the instructions were prepared for final settlement and transfer of ownership, with each party to the trade keeping the risk of the other for the next several days. Since 2009, governments have been pushing for greater use of CCPs for cash market as well as derivatives, both exchange-traded (ETDs) and over-the-counter (OTC).

Central clearing is distinguished from trade matching in that through legal novation each side to a trade takes the CCP itself as its counterpart until the trade processing is completed. The logic behind this initiative was that exchanges and their related CCPs performed well throughout the tumult of 2007-2009, and it was thought that more extensive use of clearing houses would provide stability to the financial markets. The difficulty comes in the changing nature of risk, with the push by governments to bring OTC derivatives contracts into CCPs, so mixing largely unregulated contracts with the regulated environment.

Why the new CCP environment matters to institutional investors and asset managers

First, in the trading process, asset managers will find that more of their business will be processed through CCPs, utterly changing their counterparty exposures. Second, CCPs have been assigned greater responsibilities to the markets, and with them a great deal of regulation has changed to make sure they will withstand the new environment. Notably, there are Basel III capital requirements and leverage ratios, and new oversight nationally with EMIR and CRD IV in the European Union, and the Dodd-Frank Act in the United States. Globally, the CPSS-IOSCO Principles of Financial Markets Infrastructures (the “PFMIs”) enable national authorities to review the qualitative aspects of operations of key market infrastructures, with CCPs soon to be required to disclose quantitative information on risk management and collateral valuation.

In becoming the counterparty to every transaction, CCPs concentrate risk. Most CCPs in the world are exchange-owned, and it is here that exchange capital is at risk. IOSCO has declared CCPs one of the four key risk areas for the global economy, in part because the introduction of OTC contracts adds unknown quantums to the risk profile. Given that much of the world’s financial instrument trading takes place off-exchange on platforms with varying regulatory oversight and therefore price formation of lesser value, it will be quite a challenge for clearing risk managers to run their books.

Asset owners and their managers are likely to be experiencing several new constraints, notably in margin to be provided, both in terms of the value of margin and the particular instruments judged acceptable. The clearing banks they use are subject to considerable new constraints, namely the withdrawal of some members of this mutual environment and the costs associated with maintaining higher guarantee funds. Also, depending on the jurisdiction, clearing banks have different abilities to reach back to their client for additional funding.

How Thomas Murray helps institutional investors to assess clearing risks

Thomas Murray Data Services was approached by six global clearing banks in late 2011 as these laws and regulations were being prepared, to see if its expertise in custody and central securities depositories could be applied to the clearing house environment then coming into focus. A very specific questionnaire was written on six key CCP risk areas: counterparty, asset safety, liquidity, financial, operational, and transparency and governance. The firm’s risk assessments now cover 30 of the largest CCPs in the world, with a few more to be added.

Thomas Murray Data Services' assessments have been shared with the CCPs, reviewed, and vetted by clearing banks to assure the exactitude of the assessments. The reports are maintained on-line to assure constant updating as news affects the risk profiles, complemented by a new flash service. Users of the service include national and global capital markets authorities; the firm’s conversations with them assure that its work is entirely up to date with today’s complex regulatory environment.

Thomas Murray DS is an independent firm, enabling it to be free of any ties to the infrastructures it is reviewing. Its reports are on-line and dynamic. In the case of CCPs, having been formed in local circumstances mainly for the commodities futures business, they are absolutely diverse in terms of functioning, local law and institutional rules, and risk management systems and collateral valuations. The distinctive benefit is that the firm’s reports give asset owners a lateral view across the segment and around the world, for immediate comparisons by type of risk. The reports also handle Wizard (customised) inquiries for more detailed reviews by our clients.

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If you would like to purchase this service, or find out more about it, please contact: Thomas Krantz at tkrantz@ids.thomasmurray.com or telephone him on +44 (0) 20 8600 2347