The European Securities and Markets Authority (ESMA) has published the results (PDF 4.84 MB) of its second (2017) stress test of central counterparties (CCPs).
Overall, the 2017 stress test showed that EU CCPs are resilient to common shocks and multiple defaults. However, the use of harmonised shocks for the credit risk tests highlighted some differences in resilience across central counterparties (CCPs), including some small shortfalls and higher sensitivities to price shocks and number of defaults.
The European Securities and Markets Authority (ESMA) is currently considering whether any recommendations are needed in response to identified shortcomings, and what form they should take.
The stress test focused on three major areas of potential vulnerability.
Concentration and Interconnectedness - levels of concentration to individual clearing participants do not show any systemically critical concentration to single clearing members or groups at an EU-wide level.
In terms of interconnectedness, although the largest clearing member groups have simultaneous exposures to multiple CCPs the impact of the failure of one of these groups could be met by the default fund waterfalls of these CCPs. Greater interconnectedness arises in the context of custodians, where multiple CCPs rely on a small number of cash and securities custodians, including mainly ICSDs and (for one particular currency) a single commercial bank. There is no evidence that any single financial group has provided significant committed repo lines to multiple CCPs.
Credit risk - an adverse scenario simulating the default of the largest two EU-wide clearing members, combined with a common market stress scenario, results in losses what could be absorbed by the available CCP prefunded resources, leaving no uncovered losses.
However, a separate scenario based on the default of the largest two clearing members for each individual CCP results in one case (BME Clearing) where there would be a marginal shortfall (of less than €1 million) over and above the available pre-funded resources; and one case (ICE Clear Europe), where almost all (97 percent) of the pre-funded resources would be required to cover the simulated losses. ICE Clear Europe would be vulnerable to any increase in the number of defaulting clearing members and to a small increase in the severity of the market stress scenario.
The scenario under which the largest two clearing members of each CCP default also leads to a large number of other clearing members defaulting, due to the cross-default condition. This would result in the need to call for additional non-prefunded resources at both the CCPs identified above. This knock-on analysis was also employed to assess the impact of CCPs using mutualised resources (default fund contributions and power of assessments) on non-defaulting clearing members, but this did not show any systemic implications arising from the risk-sharing mechanism of CCPs. ESMA considers the combined probability of such a large number of entities defaulting simultaneously to be very low, implying that this scenario goes beyond what can reasonably be considered to be plausible.
Liquidity - liquidity stress tests show that EU CCPs could achieve sufficient capacity to meet their liquidity needs assuming the default of two clearing members using a variety of tools, including access to central bank repo lines; access to short-term FX markets to cover requirements in some major currencies; and in one case undisrupted access to markets and the ability to settle immediately. The liquidity stress tests did not reveal any systemic risk, although as the ESMA report points out liquidity from non-central bank sources may be less reliable.