Derivatives Association Calls For Increased CCP “Skin-in-the-Game”

The International Swaps and Derivatives Association (ISDA) has called for increased transparency in the amount of capital central counterparties (CCPs) put aside in the case of a member default.

ISDA, Wall Street’s derivatives body, published a set of key principles on Tuesday on the recovery and resolution tools for CCPs, also known as clearing houses. The swaps association is the latest to criticize the safety of CCPs, as pressures mount for them to increase their “skin-in-the-game”, the amount of its own financial resources they commit in the event of a member default.

The principles call for increased transparency in the standards and methodologies used by CCPs to size their loss-absorbing resources, such as initial margin, contributions from both its members and its own funds. “Without transparency on CCP risk methodologies, the ability of market participants to accurately assess the adequacy of CCP resources is severely hampered,” ISDA says in a release.

It states there should be significant CCP skin-in-the-game, as a “CCPs’ contribution to loss-absorbing resources pool should incentivize robust risk management, align CCP management incentives with those of the clearing members, and be fully funded.”

The release of the principles comes after senior officials at the Bank of England (BoE) and European Central Bank (ECB) called for stress testing of clearing houses and suggested global regulators may introduce minimum capital levels for CCPs, similar to those recently announced for banks.

Speaking at Deutsche Boerse’s “Exchange of Ideas” conference on Monday, David Bailey, director of financial market infrastructure at the BoE, said “The FSB (Financial Stability Board) recently proposed that there must be a minimum level of Total Loss Absorbing Capacity for banks as we need to consider carefully whether and how this concept could be effectively translated to CCPs.”

However, whether these new principles would allow clearing houses to be scenarios of a member default adequately remains to be seen.

“It is very difficult to predict the conditions that would require a recovery plan to be activated. There are many unknowns and uncertainties… So it is not clear if the recovery plan will work as intended,” adds Beniot Coeure, member of the executive board, ECB.

“Some discretion is therefore needed both for the CCPs themselves and perhaps more importantly for the authorities, which cannot take a hands off approach during a crisis situation.”

Clearing houses, which stand between two parties on a trade, have become a crucial part of post-financial crisis regulations. However, with the rise in the volume of cleared trades, regulators and market participants have worried they could be the new focus of systemic risk.

J.P. Morgan, which is a clearing member to 70 CCPs around the world, has been at the forefront of this discussion. At a conference in Chicago earlier this month, it argued CCPs, such as CME Clearing, should, at least, double the amount of they devote to its default-fund.