The European Securities and Markets Authority published the results of its third stress test exercise regarding Central Counterparties (CCPs) in the European Union (EU), which confirm the overall resilience of EU CCPs to common shocks and multiple defaults for credit, liquidity and concentration stress risks. The credit stress test highlighted differences in resilience between CCPs under the selected market stress scenario, although no systemic risk has been identified.
Similarly, the liquidity stress test showed EU CCPs to be resilient under the considered scenarios and did not reveal any systemic risk. Finally, the new concentration component added a new dimension to the exercise and highlighted the need for EU CCPs to accurately account for liquidation cost within their risk frameworks. Additionally, the exercise was completed while the EU experienced a major and unprecedented crisis with the Covid-19 outbreak, which led to sharp and extreme market movements for instruments across most asset classes.
ESMA, in coordination with the NCAs, closely monitored the impact on EU CCPs, which remained resilient through the crisis, despite the increased market volatility and operational risk. ESMA’s stress scenarios were found to be overall of comparable severity with the most recent stress events.
Concentration risk
The EU-wide concentration analysis shows that concentrated positions represent a significant risk for EU CCPs. For most asset classes, concentrated position risk is clustered in one or 2 CCPs. At EU level, the largest concentration risk can be found in fixed income, with around €20 billion ($22.7bn). Concentration in commodity derivatives and in the equity segment (securities and derivatives) is also significant, with around €9.5 billion of concentration risk.
The analysis found that concentration risk is factored in explicitly in a majority of CCPs, through dedicated margin add-ons. However, these add-ons are not always sufficient to cover the market impact, with a very large coverage gap on aggregate for commodity derivatives and to a lesser extent for equity products. In addition, a focus on individual clearing members coverage shows that concentration risk is not always covered properly at this level, as 4 CCPs have at least a clearing member whose market impact exceeds its total required margin. This highlights the importance for margin models to be conservative and accurate in capturing concentration risk.
Comments from the chair
Steven Maijoor, ESMA’s chair, said in a statement: “ESMA’s third stress test of CCPs in the EU has found that overall CCPs are capable of withstanding severe shocks under common shocks and simultaneous defaults. This resilience was also demonstrated during the unexpected and unprecedented impact of the COVID-19 pandemic on the global financial system. This provides reassurance given the key role these market infrastructures play.
“CCPs are at the heart of the financial system and the failure of one CCP has the potential to cause serious systemic risk across the EU. Therefore, testing whether CCPs can withstand extreme scenarios involving clearing member defaults and simultaneous market price shocks is an important supervisory tool in mitigating systemic risk.
“The CCP stress test remains a key supervisory tool for EU regulators in ensuring systemic resilience, financial stability and orderly markets. The importance of this tool was recognised in the EMIR review and has been extended to cover systemically important Tier 2 third-country CCPs in future.”