Moodys comments (see below) cover the recent announcement from the (IOSCO) which reported deficient implementation of regulatory standards in risk management and recovery planning at some central counterparty clearing houses (CCPs), and said that some of the deficiencies warrant immediate attention.
Moodys says the deficiencies are credit negative for the affected CCPs, which are not identified but are among the 19 globally active and regional CCPs from 17 jurisdictions assessed within the report. CCP members and the members end-users are also exposed to the potential adverse effects of the CCPs deficiencies. CPMI-IOSCO said it falls within the responsibility of relevant supervisory authorities to ensure that individual CCPs follow regulatory standards.
CPMI-IOSCOs assessment covered three areas: recovery planning, liquidity stress testing and coverage of financial resources.
As of the reports 1 January 2017 effective date, three CCPs were still implementing rules and arrangements in their recovery plans. CPMI-IOSCO said these CCPs lack of a fully implemented comprehensive and effective recovery plan was a serious issue that should be addressed with the highest priority. In managing risk, CCPs should identify in advance the extreme circumstances that could threaten their viability and financial strength and maintain an effective plan to maintain critical services should these circumstances occur.
The report covered four other high-priority deficiencies. Some CCPs use only one capped tool to address uncovered credit losses, and reliance on this tool alone may be insufficient for a CCP to comprehensively allocate uncovered losses. Some CCPs do not have mandatory rule-based recovery tools to re-establish a matched book, and it is unclear whether these CCPs reliance on voluntary, market-based tools alone would effectively restore a matched book. Certain tools CCPs identified to address liquidity shortfalls appear inconsistent with regulatory standards. And, a small number of CCPs lacked rules and procedures that indicate processes to replenish any financial resource use during a participant default to allow the CCP to continue to operate in a safe and sound manner.
Liquidity stress testing
Some CCPs liquidity stress tests lack a sufficiently wide range of scenarios to account for the material liquidity risk of other participants nonperformance, a high-priority deficiency. CCPs must plan to have sufficient liquid resources in the event of a member default or a wide range of other potential stress scenarios, including those affecting other participants in the clearing process, such as settlement banks, custodians and liquidity providers. Another serious issue was that some CCPs, in addressing uncovered liquidity shortfalls, rely exclusively on tools designed to address uncovered credit losses, rather than losses resulting from other factors.
Coverage of financial resources
CCPs must maintain sufficient prefunded financial resources to cover a wide range of potential stress scenarios, including from member defaults. Although all the CCPs have procedures designed to maintain sufficient financial resources, some CCPs reported one or more breaches during the review period. During 2016, one CCP had breaches on 142 days for exchange-traded derivatives and 88 days for over-the-counter derivatives, suggesting a significant shortcoming to address a breach.
And, some CCPs have practices that lead to insufficient or protracted responses to a breach in coverage that could cause them to fall short of achieving outcomes consistent with regulatory standards.