Finextra discusses CCPs as 鈥渢oo big to fail鈥�
28 November 2012 New York
Image: Shutterstock
Even though the market has not witnessed a massive meltdown of central counterparties (CCPs) and its paralysing effect, regulators are taking precautions, says Finextra.
In a blog post, the firm discussed the various merits and downfalls of CCPs, stating that benefits such as lower settlement costs and reduced risk offset their vulnerability, so long as they are properly managed and well capitalised.
鈥淐CPs can potentially pose significant systemic risk to the market, with the concentrated risk that they take on. There have been heated discussions about the vulnerability of CCPs in distressed market situations."
"Some even start to apply the term 'too big to fail' to CCPs. How do CCPs usually manage their risk and what is the sequence of events when a participating member defaults?"
鈥淚n the event of a member default as defined in the CCP default rules (eg, fail to settle, fail to pay fees), the CCP can claim the member to be in a non-conforming or default status 鈥� the CCP may seize the default member鈥檚 assets, and then either transfers the assets to another member or auctions the portfolio to other members," said the firm.
"To cover the induced loss from the default member, the CCP鈥檚 first recourse is to seize the default member鈥檚 resources, including the collateral it pledged for margins and its contribution to the default fund. If the above resources are not sufficient to cover the loss, the CCP will look to its own capital reserved for this purpose and then the remaining default fund contributed by members still in good standing.鈥�
Finextra concluded by predicting that even though the market has not witnessed CCP failure as of yet, regulators will step up their game to avoid a CCP meltdown.
In a blog post, the firm discussed the various merits and downfalls of CCPs, stating that benefits such as lower settlement costs and reduced risk offset their vulnerability, so long as they are properly managed and well capitalised.
鈥淐CPs can potentially pose significant systemic risk to the market, with the concentrated risk that they take on. There have been heated discussions about the vulnerability of CCPs in distressed market situations."
"Some even start to apply the term 'too big to fail' to CCPs. How do CCPs usually manage their risk and what is the sequence of events when a participating member defaults?"
鈥淚n the event of a member default as defined in the CCP default rules (eg, fail to settle, fail to pay fees), the CCP can claim the member to be in a non-conforming or default status 鈥� the CCP may seize the default member鈥檚 assets, and then either transfers the assets to another member or auctions the portfolio to other members," said the firm.
"To cover the induced loss from the default member, the CCP鈥檚 first recourse is to seize the default member鈥檚 resources, including the collateral it pledged for margins and its contribution to the default fund. If the above resources are not sufficient to cover the loss, the CCP will look to its own capital reserved for this purpose and then the remaining default fund contributed by members still in good standing.鈥�
Finextra concluded by predicting that even though the market has not witnessed CCP failure as of yet, regulators will step up their game to avoid a CCP meltdown.
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