CCP failure, CVA gaps and passporting

The week on Risk.net, August 12–18, 2016

CCP RECOVERY plans running late

CVA could miss half of true default risk

PASSPORTING clouds for UK commodity firms

 

COMMENTARY: The shadow of hub risk

Central clearing is at the heart of the post-crisis financial world, and central counterparties (CCPs) have made a great deal of progress in moving financial products of all kinds from bilateral to centrally cleared trading. Most recently, HKEx became the first CCP to clear cross-currency swaps – largely thanks to Hong Kong's multi-currency settlement system. The ability to net out trade payment flows insulates HKEx from the margin-busting spikes in exposure that would otherwise result.

The big question is whether the cleared market can withstand a major systemic event – the kind that could put at risk a number of the banks that are CCPs' biggest users.

Remember, this is the main reason for shifting to central clearing in the first place – that a financial system consisting of a closely coupled network of bilateral trading relationships would allow a crisis to spread too fast, and a hub-and-spoke system based on adequately funded CCPs would be more robust. Contagion risk would be replaced by hub risk, with the latter watched and controlled more tightly. Or so the theory goes.

The Bank for International Settlements and the International Organisation of Securities Commissioners, which reported on CCP resilience recently, are not convinced all CCPs would survive a systemic event. They do not always meet the "cover two" standard of clearing house resilience, the report found, meaning they could be vulnerable if two of their members fail simultaneously. Plans to rely on members to increase collateral contributions as risks rise could end up being procyclical, and spreading the crisis they are trying to contain.

One solution could be to pre-fund CCPs to a much higher level using catastrophe bonds – already in use by insurers to manage the risk of major natural disasters – though this will need to be carefully handled to avoid creating moral hazard. In a hub-based financial world, regulators have bet the house on the stability of the hubs under all circumstances – they, and their markets, cannot afford for this to be thrown into doubt.

 

STAT OF THE WEEK

Brexit could mean the end of market coupling – the simultaneous purchase of power and capacity – which could cost the UK up to £200 million ($263 million) per year, according to a study by UK transmission system operator National Grid.


QUOTE OF THE WEEK

"Wherever there are derivatives and there are benchmarks, there is a potential for someone to seek advantage. And that's what we look for" – Matthew Hunter, head of surveillance with the Commodity Futures Trading Commission's division of market oversight.


ALSO THIS WEEK

Dealers warm to all-to-all CDX trading
Liquidity providers new and old want to build on Bloomberg Clob activity

Three lines of defence model comes under attack
Operational risk managers say the idea is too formalised and beset by implementation challenges

China leverage clampdown to hit two-tier structured products
Product issuers look to derivatives to boost returns, but options are limited

Insurance capital standard can be forged on time - Cadoni
Chair of IAIS working group asserts ICS will not be mere capital backstop

What a star 1,480 light years away can teach risk managers
Amateur astronomers' discovery shows value of humans over algorithms

New accounting rules expected to hit US banks hardest
FASB's Cecl rule could mean loss provisions for loans are three times higher compared with IFRS 9

Buy side backs call for US Treasury new-for-old scheme
A programme of bond exchanges could revive liquidity in off-the-runs

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