The European Association of CCP Clearing Houses (EACH) published a paper on “Best Practices in CCP Credit Risk Management”. Credit risk refers to the potential loss that a counterparty may suffer if a counterparty on the other side of the transaction fails to fulfil its contractual obligations. Credit risk is one of the main types of risks that CCPs are designed to manage, together with market, concentration and liquidity risks amongst other.
The best practices described in the paper are designed to be kept outside and in addition to the European Market Infrastructure Regulation (EMIR) regulatory framework, providing CCPs discretion with the operationalization of their risk management framework.
The paper describes the following six principles for CCPs’ addressing credit risk:
- Governance – maintaining a robust and holistic credit risk assessment and management framework that represents market best practice means the governance framework can and must ensure that credit risk for all relevant entities is proactively monitored and assessed.
- Model validation – scorecard models developed to support the process of reviewing Counterparty rating systems shall be regularly validated and managed to limit model risk in a controlled environment and should meet certain key criteria.
- Annual credit review – the scorecard credit rating model should be reviewed on an annual basis to ensure it continues to fulfil its purposes.
- Operational capabilities – the operational set-up of clearing members needs to be suitable for the business model.
- Risk management capabilities – clearing members need to have an independent risk management function which should follow a certain practice.
- Portfolio monitoring – the credit portfolio needs to be monitored with suitable early warning indicators (EWIs), such as: CDS spreads; share price; monitoring high attention names; external ratings agency/credit benchmark downgrade; late payment of margin; news alerts.