Moody’s has proposed a ratings methodology for CCPs.
The analytical factors underlying the clearing counterparty ratings (CCR) take into account CCPs’ clearing member default management capabilities and related structural protections, their business and financial fundamentals and their operating environments, and lays out the key quantitative metrics and qualitative factors the ratings agency considers in reaching a rating determination.
Since the fall of Lehman, global regulators and standard setters have been moving toward mandatory central clearing of OTC derivatives as a means of minimizing systemic financial risks related to uncertainty of the size and nature of firms’ derivatives exposures. This increased channeling of financial market activity to the clearing houses has made the role of the CCP more critical to the health of the financial system.
Moody’s says the CCR reflects the CCP’s ability to meet its clearing and settlement obligations to its clearing members and the financial loss that would result if a CCP is unable to meet such obligations.
It will assess and measure a CCP’s intrinsic credit strength, its operating environment, qualitative adjustments; and affiliate and systemic support as key factors when assigning a rating.
Moody’s approach to assigning the CCR starts with two key factors, to arrive at a measure of a CCP’s intrinsic credit strength (ICS):
» Default management capabilities (DMC) – assesses the CCP’s unique risk by gauging how it manages counterparty risk, product risk and waterfall resources
» Corporate profile (CP) – assesses the CCP’s business and financial profile, with a focus on its competitive position, liquidity coverage and other general business risks
It considers factors from its sovereign rating methodology, namely, institutional strength, economic strength and susceptibility to event risk, each weighted according to its particular relevance to the CCP. Moody’s score for a CCP’s operating environment also takes into account industry-specific factors, such as industry structure and strength of regulatory oversight.
It then considers important qualitative credit factors that contribute to a CCP’s soundness but are non-financial, or are financial but not readily assessed by common standard ratios. These factors include a CCP’s relative vulnerability to corporate behavior and operational risk, which could lead to positive or negative adjustments that will be reflected in the preliminary CCR.
Moody’s then concludes its analysis and arrive at a CCR by assessing the potential risks and support arising from a CCP’s parent, affiliates, and local government.
To mitigate the risks of a clearing member default and the product risks associated with the clearing obligations a defaulting member would have with a CCP, a CCP relies on its waterfall resources. These waterfall resources include margin, default fund contributions provided by the defaulting members and non-defaulting members, both pre-funded and contingent (as part of assessment powers), as well as the CCP’s own capital contributions (i.e., its skin-in-the-game). If these resources are insufficient to close out the portfolio of a defaulting clearing member, the CCP could make further resource demands on clearing members in line with the contractual requirements of their membership.
To assess waterfall resources, Moody’s considers a CCP’s adherence to the IOSCO Principles for Financial Market Infrastructures, whether it has been recognised as a Qualifying CCP or met a similar designation, as well as its local jurisdiction’s progress in implementing central clearing reform. At a minimum, CCPs are required to publish their own self-assessment of their adherence to IOSCO.
Margin is the key to the overall strength of the waterfall. Margin can create an incentive for clearing members to limit excessive risk in their open positions, because they must pay for that risk (via a larger margin requirement).
Moody’s first considers a CCP’s margin collateral policy, reviewing the asset quality of collateral accepted for margin and the haircutting policy applied to collateral.
It then assess a CCP’s collateral investment policy. An aggressive investment policy could lead to shortfalls in a CCP’s default management resources, which is likely to result in a reduction of one or more notches in our score on waterfall resources, says Moody’s.
Lastly, Moody’s considers additional liquid resources, such as bank committed liquidity facilities, which might be available to manage the liquidity demands of the close-out process, as well as any non-default liquidity needs of the clearing and settlement process.
Moody’s Proposes First Ratings Methodology for CCPs
Moody’s has proposed a ratings methodology for CCPs.