SLIB
Speaking at the SLIB Counterparty Risk Roundtable, Kazimierz Sycz argues that worries over CCPs are, for the most part, overstated
What effect has the introduction of EMIR and the mandate for central clearing had on the European market?
Central counterparties (CCPs) have been there for years. The first clearinghouses opened in the nineteenth century, and they started taking on risks as true CCPs in the 1920s. What is new now is the mandate to clear OTC derivatives, but Europe has had a CCP for OTC interest rate swaps ever since 1999, which is also when it started clearing cash securities.
The definition of a CCP is risk management. It is not there to help firms streamline processing; it is there, first of all, to guarantee the trade. If traders do not work through a CCP, they are directly exposed to the risks, they have to know and trust each counterparty that they deal with. With the CCP in between, they can trade with more counterparties, and it is easier to unwind a position. This is an important new thing in OTC derivatives.
The European Market Infrastructure Regulation (EMIR) also covers listed derivatives and securities. EMIR has tightened up risk management across asset classes, meaning clearers have had to adapt their systems to the new features in all the different CCPs. But they’re also making changes that are inspired by EMIR, and not necessarily regulatory. Many are simply treating the risks more seriously. For securities these are the main contributions.
Some banks have expressed concern over the financial stability of CCPs. Is that something you see as a problem?
From the point of view of a clearing member, if the CCP defaults, then it is in serious trouble. So, of course, the CCP does pose a risk, however unlikely. Many used to think the CCPs were set in stone. Now they’re realising that they could default, and if they do, there will be a big problem.
But it is a problem that is being tackled. This topic is being heavily discussed now because it is new, in the sense that many have only just become aware of it, but we should not overestimate the issue. When you see the amount of time spent on it in the press, it seems like overkill.
Work in this area is coordinated quite nicely by the Financial Stability Board. If there is an issue around systemic risk, then it is for the top regulatory boards to worry about. There are other questions more important for our daily practice, for example, whether all participants in the post-trade chain have their risks fully covered. In my opinion, this is an issue that is being fairly underestimated in comparison.
The governor of the US Federal Reserve has stated that there is still a lot of work to do with CCPs. Would you agree with that?
Certainly. The Federal Reserve’s focus is on systemic risk: can we let a CCP fail? How can we prevent that? How can we contain contagion if it does fail? These are the same questions we are asking of all institutions that are deemed systematically important. A piece of regulation that is good for systematically important banks will usually be good for CCPs, too, but there will be many specific points to address for each individual CCP business, whether it’s securities, derivatives, or somthing else.
Apart from systemic risk, there is quite a lot of work to do in the risk management for cleared trades. The industry is starting to move past EMIR, and some participants may have been lulled into thinking that all of the issues have been overcome. Well, not yet. There is always a standoff when it comes to regulations, because ideas need time to develop but there is always a deadline. For me, the process is not finished yet.
For example, for CCPs we need a uniform framework for stress testing and for backtesting; for clearing members, we need the stop button; for the custodian, we need an estimation of the settlement risk. We have come to realise that there are weak links in the chain, and this is still in the process of being addressed. It is happening, and it is becoming clear that there are a lot of very interesting things to come.
