Specific recovery and resolution frameworks for financial market infrastructures support the benefits of the CCP model
Central clearing significantly reduces systemic risk and their amplifying factors in financial markets. This is a key finding of a white paper which we recently published entitled “How central counterparties strengthen the safety and integrity of financial markets”.
The white paper describes how CCPs protect Clearing Members and their clients from systemic risk in OTC derivatives markets as independent risk managers. The main takeaways are:
CCPs reduce systemic risk by lowering interconnectedness among market participants and by mitigating excessive risk taking by collateralization and neutral valuation.
Protection mechanisms (i.e. lines of defense) inherent in CCPs’ designs contain the spread of losses if a Clearing Member defaults.
Transparency and strict risk management standards of CCPs foster confidence, especially critical during turbulent times.
In protecting Clearing Members and their clients, CCPs need to adhere to the highest standards to mitigate potential negative impact of disruptions of CCPs on the financial market.
As such, the regulatory drive to broaden CCP use to OTC derivatives will benefit the financial marketplace and the wider economy. CCPs like Eurex Clearing proved their resilience during the 2008 default of Lehman Brothers and have further improved their quality standards since then. Collateral posted by Lehman Brothers itself covered the resulting losses, shielding other Clearing Members from their impact. However, CCPs are even preparing for market scenarios more severe than the 2008 financial crisis in order to ensure their own safety and integrity.
In order to prepare for unprecedented and unforeseen events that could affect them and their operations, CCPs are drafting recovery and resolution plans as last resort. These plans will improve the resilience of CCPs ex ante, and enable the CCP and its stakeholders to act decisively to resolve a potential crisis.
The white paper is available here.