Featured Product

    OFR Paper Examining the Vulnerability of CCPs in Derivatives Market

    November 02, 2017

    OFR published a working paper that examines the likelihood that a central counterparty (CCP) will default after a severe credit shock. The paper used credit default swap (CDS) data to estimate the direct and indirect effects of a default by CCP in derivatives trades. The paper concludes that a CCP could be more vulnerable to failure than conventional stress tests have shown.

    The paper proposes a general framework for estimating the likelihood of default by central counterparties (CCP) in derivatives markets. Unlike conventional stress testing approaches, which estimate the ability of a CCP to withstand nonpayment by its two largest counterparties, the authors studied the direct and indirect effects of nonpayment by members and/or their clients through the full network of exposures. The authors illustrate the approach for the CDS market under shocks that are similar in magnitude to the FED’s 2015 Comprehensive Capital Analysis and Review trading book shock. The analysis indicates that conventional stress testing approaches may underestimate the potential vulnerability of the main CCP for this market.  

    The paper summarizes the protections that the CCP has in place to deal with defaults by its members and examines the way the Depository Trust & Clearing Corporation (DTCC) data is used to derive variation margin payment demands and failure probabilities under the CCAR shock. The paper then analyzes the Cover 2 standard in the context of the CCAR shock. This analysis suggests that the CCP’s default fund is adequate to cover the defaults of its two largest members; however, a different conclusion emerges when network contagion is taken into account. The paper introduces the contagion model, which traces how payment delinquencies by some firms can escalate as they cascade through the network of CDS exposures. The sensitivity of the model to different values for the shock and stress transmission parameters is also demonstrated. Next, the paper describes a probabilistic model that allows the estimation of the probability of a CCP failure relative to the probability of a member’s failure, while making minimal assumptions about the degree of correlation among member failure rates. This model was used to estimate the probability that a CCP would default during a stress of similar magnitude to the CCAR shock. 

     

    Related Link: Working Paper (PDF) 

    Keywords: Americas, US, Securities, CCP, CCAR, OTC Derivatives, CDS, Stress Testing, Systemic Risk, OFR

    Featured Experts
    Related Articles
    News

    OCC Revises Minimum Threshold for Banks to Conduct Stress Tests

    OCC issued the final rule that amends its company-run stress testing requirements under the 12 CFR 46 in Code of Federal Regulations.

    October 10, 2019 WebPage Regulatory News
    News

    US Agencies Update Management Interlock Rules Under DIMIA

    US Agencies (FDIC, FED, and OCC) issued a final rule that increases the thresholds in the major assets prohibition for management interlocks for purposes of the Depository Institution Management Interlocks Act (DIMIA).

    October 10, 2019 WebPage Regulatory News
    News

    US Agencies Finalize Rules to Closely Match Bank Risk Profiles

    US Agencies (OCC, FED, and FDIC) finalized rules that tailor the regulations for domestic and foreign banks to more closely match their risk profiles.

    October 10, 2019 WebPage Regulatory News
    News

    CPMI-IOSCO and FSB on Governance Arrangements for OTC Derivatives

    CPMI and IOSCO published a report that identifies key criteria, functions, and bodies for the governance arrangements.

    October 09, 2019 WebPage Regulatory News
    News

    EIOPA Launches Field Test on Templates Under 2020 Solvency II Review

    EIOPA, as part of the 2020 Solvency II reporting and disclosure review, launched a field test on the revised and newly proposed reporting templates.

    October 09, 2019 WebPage Regulatory News
    News

    US Agencies Adopt Rule on Appraisals for Real Estate Transactions

    US Agencies (FDIC, FED, and OCC) adopted the final rule to amend regulations requiring appraisals of real estate for certain transactions

    October 08, 2019 WebPage Regulatory News
    News

    US Agencies Finalize Amendments to Simplify Volcker Rule

    US Agencies (CFTC, FDIC, FED, OCC, and SEC) finalized amendments to the regulations implementing section 13 of the Bank Holding Company Act, also known as the Volcker Rule.

    October 08, 2019 WebPage Regulatory News
    News

    EC Report Explores Application and Challenges of Blockchain Technology

    The Joint Research Center of EC published a report exploring the challenges and impact of distributed ledger technologies.

    October 08, 2019 WebPage Regulatory News
    News

    BIS and SNB Sign Agreement on Innovation Hub Center in Switzerland

    BIS and SNB signed an operational agreement on the BIS Innovation Hub Center in Switzerland.

    October 08, 2019 WebPage Regulatory News
    News

    ECB Issues Results of Sensitivity Analysis of Liquidity Risk for Banks

    ECB published results of 2019 stress test on sensitivity analysis of liquidity risk.

    October 07, 2019 WebPage Regulatory News
    RESULTS 1 - 10 OF 3958