ESMA stress test finds that concentration and operational risks should be reduced in CCPs

The regulators fourth test of Central Counterparties (CCPs) showed proof of resilience but found that there was room to improve risk management frameworks.

The European Securities and Markets Authority (ESMA) has published the results of its fourth test exercise of Central Counterparties (CCPs), confirming the overall resilience of CCPs in the Bloc and third-country Tier 2 CCPs.

Despite being resilient overall, the stress test identified areas where CCPs could strengthen their risk management frameworks or where additional supervisory work should be prioritised, including around concentration and operational risks.

According to ESMA’s report, operational risk is substantial for CCPs and this in turn may impact their resilience, clearing and settlement activity or some of their critical supporting functions. ESMA found that a variation exists across CCPs both with regards to general level of operational risk measured and to the presence of incidents with long remediation timeframes or recurrence.

Moving forward, the watchdog said it believes additional work on a consistent reporting of  risk events may be warranted. CCPs currently disclose public information on availability through the CPMIIOSCO disclosures, however, ESMA states that a more consistent framework for collecting and reporting operational risk events to NCAs is needed.

Following an evaluation of the exposure of CCPs to critical third-party service providers as well as their ability to reduce risk through operational risk management tools, ESMA found that more work is needed to analyse this at both an individual CCP level and system wide, to allow operational resilience to be strengthened.

The watchdog’s European-wide concentration analysis also found that concentrated positions represent a significant risk for CCPs. The majority of asset classes have concentrated position risk clustered in one or two CCPs and ESMA found that concentration risk is factored in explicitly in most CCPs through dedicated margin add-ons.

“ESMA’s fourth stress test found that the European clearing market is resilient and capable of withstanding severe stress scenarios, although certain areas need further strengthening. CCPs’ resilience was confirmed during the real-life market stress following Russia’s invasion of Ukraine,” said Klaus Löber, chair of the CCP Supervisory Committee.

“CCPs are of critical importance to the stability of the financial system and the failure of one CCP has the potential to cause serious systemic risk across the EU. Therefore, stress testing CCPs is a key supervisory tool to understand the clearing industry, identify issues relevant for financial stability and eventually mitigate systemic risk, contributing to ESMA’s mission.”

Earlier this year, ESMA extended the recognition status of three UK clearing counterparties in Europe for a further three years. ICE Clear Europe and the London Stock Exchange Group’s (LSEG) LCH will retain their Tier 2 status in Europe and the London Metal Exchange (LME) will retain its Tier 1 status, until 30 June 2025.