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The Essential Components of The Risk Management Framework for CCPs

Traders Magazine Online News, January 15, 2019

Dale Michaels

Central counterparties (CCPs) like OCC have performed extraordinarily well during many stressful periods, including the financial crisis of 2008. This is due to the many clearinghouse innovations that have been put in place, including mark-to-market settlements, initial margin models, and default management processes. As a reminder, CCPs do not take on any market risk. Instead, we manage risk. We add a critical risk management function to the financial system and, when one of our clearing members is in default, we act, as we did in the wake of Lehman, MF Global and others.

CCPs have become more critical to the financial industry, as reflected in our designation as systemically important financial market utilities. We have endeavored to make our processes even more transparent to the public, with the adherence to the Principles for Financial Market Infrastructures (PFMIs) and the distribution of both qualitative and quantitative information, so that market users can better understand the overall risk management of CCPs and participate in risk committees or other advisory forums.

Clearing Members
At OCC, we look to have a broad clearing membership that includes all qualified participants, as we want to have a large and diversified set of clearing members. Initially, we consider whether potential clearing members are regulated entities. In the U.S., this means that they are either a registered broker-dealer or a futures commission merchant (FCM), and that they are a corporate entity.

Most importantly, each CCP continually monitors the credit risk of each of its clearing members that bring exposures to the clearing house by reviewing financial statements and market metrics. At OCC, we take this a step further and perform a risk review of each of our members, both at initial admission to membership and periodically thereafter, to ensure that they meet acceptable risk management standards.

Initial Margin
CCPs' initial margin models are distinct from one another to reflect differences in the products and their inherent risks. This distinction prevents model risk that is created when using a single approach without tailoring it to specific circumstances. Much of the work CCPs do with regard to initial margin requirements is appropriately calibrating and reviewing initial margin models as conditions and products evolve. This process is one of the most critically important for CCPs. In this regard, OCC developed a 10,000 scenario Monte-Carlo initial margin calculation methodology called STANS. At OCC, the STANS (System for Theoretical Analysis and Numerical Simulations) margin approach is based on expected shortfall at a 99.0 percent level, which means we include all observations, including the worst-case scenarios, and average those amounts from 99 to 100 percent. OCC also employs a two-day margin period of risk for its initial margin model, which like the expected shortfall approach, exceeds the regulatory standards for exchange-traded derivatives to cover a 99 percent confidence level and a one-day margin period of risk.

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