Measuring clearing houses' risk

Clearing houses could pose the biggest risk in a future crisis. It’s a statement being echoed in every corner of the financial system lately, including by Bank of England deputy governor Paul Tucker, who uttered it at a Parliament committee earlier this month.

This week, Werner Bijkerk, head of research at the International Organisation of Securities Commissions (IOSCO), said the failure of a clearing house or central counterparty (CCP) could be “catastrophic”, as they are beginning to be too-big-to-fail.

When the 2008 financial crisis struck, it was the banks carrying the risk. After billion-dollar bailouts, rule changes aimed at preventing the same occurrence in the future appear to have only moved the risk from banks to CCPs. 

In line with G-20 reforms, the US Dodd-Frank Act and the European market infrastructure regulation mandate the central clearing of OTC derivatives trades.  

The challenge for regulators now is making sure CCPs can handle any future stress. IOSCO and the Committee on Payments and Settlement Systems (CPSS) last year released 24 ‘Principles for financial market infrastructures’ to help achieve effective risk management, strong governance and oversight.

As outlined in the principles, IOSCO believes information needs to be made publicly available to understand the risks CCPs are now carrying. As a result, this week the Commission released a consultative document on the quantitative data that CCPs should release. 

The objective, according to IOSCO, is to compare CCP risk controls, including financial condition and financial resources to withstand potential losses; have a clear, accurate and full understanding of the risks associated with CCP; and understand and assess the risks of participating in CCPs.

Among the information to be disclosed is the total value of default resources and the estimated largest aggregate credit exposure that would be caused by the default of any single participant in extreme market conditions.  

CCPs would also need to disclose peak daily value of contracts, split by each type of physical commodity and type of security delivered by a single participant.

IOSCO asks whether this disclosure would allow informed market participants to identify individuals, and if so, would that be materially commercially prejudicial to CCP participants and why. 

Other questions include: Would it be useful to publish quantitative disclosures following a default, with a suitable lag? How long the default would be appropriate? What summary statistics could be disclosed without revealing sensitive information?

The Commission is taking submissions until 13 December. Once that process is done, the question will then be what are regulators and market participants do with all this data?

Will people read it? And will it in fact help keep a pulse of the risk of CCPs?

Whatever the result, it’s a debate worth having.