Do CCPs Need More Skin in the Game?

Man up and open your wallet was the advice that buy- and sell-side gave to derivatives clearing organization (DCO) operators when the Commodity Futures Trading Commission (CFTC) held an industry discussion on a catastrophic failure of a clearinghouse.

Would additional DCO contributions significantly mitigate members loses if the five or six largestclearinghousemembers defaulted simultaneously, which was the CFTC scenario?

To paint an even darker picture, CFTC officials suggested that those members’ initial margins, guaranty-fund contributions, individual clearinghouse assessments, and the liquidation of their positions were notenough to cover the outstanding loses.

One potential solution could having the clearinghouses have access to ample resources before such a massive default and stop the scenario from happening and clearinghouse contributions would be a perfect place to start,suggests Kristen Walters, global chief operating officer for asset manager BlackRocks risk and quantitative analysis group.

Now that a number of central counterparties are for profit, this concept of having fully funded capital that indue a risk-based assessment relative to the overall fund itself is very important, she said.

Every DCO is obligated to contribute to its guaranty fund, but the amounts vary from DCO to DCO.

Looking at the separately managed guaranty funds dedicated for cleared interest-rate and credit-default swaps, CME Clearing, ICE Clear Credit, and LCH.Clearnets SwapClear US contributed $150 million, $50 million and $2 million to their guaranty funds, which represents 2.2%, 2%, and 0.3% of their guaranty funds total assets respectively, according to their 2014 earning reports.

Its questionable if further DCO contributions could make most, some, or even a few lucky member firms whole after such a market implosion.

ICE Clear Credit and ICE Clear Europe generated $97 million in revenue in 2014, which is slightly less than double its current guaranty-fund contributions. (The Intercontinental Exchange did not break out the individual earnings of its swaps clearing businesses.)

On the other hand, SwapsClear US reported an approximately $10 million operating loss over the same period.

It would be interesting to know how much CME Group made or lost from its clearing of interest-rate and credit-default swap trades, but the exchange operator did not list those numbers separately in its annual report.

Increased clearinghouse contributions may raise the morale of those suffering loses, but in actuality it is as productive as trying to fill in the Grand Canyon with a garden trowel. Its all about scale.