The European Association of CCP Clearing Houses (EACH) has argued the importance of the ‘skin in the game’ (SIG) component of the central counterparties (CCP) risk management structure.
In its new paper, Carrots and sticks: How the skin in the game incentivises CCPs to perform robust risk management, EACH discusses the concept of SIG, considers its purpose, and compares it to the purpose of other default management resources available at CCP level as part of the CCP’s default waterfall.
EACH suggests that the current calibration of SIG as included in the European Market Infrastructure Regulation (EMIR) is adequate.
The purpose of SIG is to ensure the CCP is incentivised to perform robust risk management and that an alignment between the CCP and clearing members’ interests is in place.
According to EACH, with their own funds at risk immediately after the contributions of the defaulting clearing member are exhausted, CCPs are very strongly incentivised to exercise robust risk management to limit the impact on their own funds, thereby limiting the impact on non-defaulted members’ funds.
It ensures the CCP’s prudent risk management strategies while demonstrating the correct incentive alignment between the CCP and the members for the CCP to perform optimal risk
management and for the members to contribute to the default fund and default management procedures.
In addition, it acts in conjunction with existing default management policies to ensure all participants act in the best interest of the market in a time of market stress.
EACH believes the calibration of SIG as defined under EMIR is proportionate to the size of the CCP, reflects the role of the CCP as a risk manager and is calculated on the capital that covers the risk that the CCP is responsible for (regulatory capital).
The association considers this calibration is sufficient in approach and in magnitude. The association believes calibrating SIG on any other base would effectively create confusion between the role of risk manager (CCP) and the position of risk taker (clearing members), misaligning the incentives between the CCP and its clearing members.
EACH highlights that any attempt to alter the current calibration of the CCP’s SIG under EMIR as a potential threat to the risk management benefits provided by CCPs, which were crucial to contain the recent financial crisis.
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