The Clearing House Association, an advocacy organization representing major banks, recently released a paper detailing the results of a six month study into ways central counterparties (CCPs) could better protect themselves. The need comes as a number of over-the-counter (OTC) derivatives have been mandated internationally to move toward central clearing.

According to Alex Radetsky, vice president and assistant general counsel at The Clearing House Association, the study was undertaken to provide a bank-specific view toward the issue of central clearing. “There has been significant discussion about central clearing, CCPs and systemic risk, but less so with regards to the effect that market stress or a default could have on a clearing member. Our paper looks at those issues through the lens of the various banks that are, or are affiliated with, the clearing members at the CCPs,” he says.

With the move toward central clearing, Radetsky says systemic risk is shifting onto clearinghouses as more products are moved away from OTC. The paper outlines nine specific recommendations. “We’re most concerned with mitigating contagion, such that a default would not spread throughout the financial system,” he says.

The recommendations range throughout the CCPs’ area of business, but most focus on risk and liquidity management. By defining and limiting the CCPs’ risk in these areas, Radetsky says customers would feel more secure “knowing that the financial institution that they do business with — their broker for these types of transactions — is made a little more secure.”

The paper's nine specific recommendations are:

• Clearing Member liability must be limited, ascertainable and manageable.
• CCPs must have appropriate “skin in the game.”
• Initial margin should be limited to cash and high-quality, liquid instruments.
• CM collateral should be subject to investment and custodial risk protections.
• Potentially unrealistic liquidity demands must be addressed.
• Liquidity demands on CMs from intraday margin calls must be coordinated.
• CCP emergency authority must effectively balance competing interests.
• Enhanced CCP transparency is critical to effective CM risk management.
• Losses within a product type should be silo’d to mitigate the risk of contagion.

Click here for The Clearing House’s brief on the report
Click here for The Clearing House’s full report