United States: CFTC Staff Reports On Supervisory Stress Tests Of Clearinghouses (With Delta Strategy Group Summary)

Last Updated: November 22 2016
Article by Robert Zwirb

Most Read Contributor in United States, September 2017

The CFTC released a staff report that summarized the results of eleven internally developed supervisory stress tests that were applied to five CFTC-registered derivatives clearing organizations ("DCOs").

In the report, CFTC staff determined that:

  • clearinghouses had the financial resources to withstand a variety of extreme market price changes across a wide range of products and instruments – they met or exceeded required resiliency levels;
  • clearinghouses had sufficient financial resources to cover a default by at least two clearing members (including affiliates) with the largest margin shortfalls – the so-called "cover-two" standard – in all of the stress tests. The cover two standard is a U.S. and international requirement for certain systemically important clearinghouses; and
  • for almost two-thirds of the stress tests, the applicable clearinghouse had sufficient financial resources to cover a default by every clearing member in the exercise that incurred a loss ("cover-all").

Notwithstanding these positive results, the report noted, the exercise had a "number of limitations": it analyzed only a limited set of scenarios, applied only the impact of extreme price changes over a one-day period, and did not take strains on liquidity into account.

The report stated that CFTC staff plans to conduct exercises of this kind on a regular basis. According to the report, enhancements to future exercises should include (i) extending the analysis of single-day events to three-day scenarios, (ii) adding additional scenarios and products, (iii) comparing losses to required margin at clearinghouses, (iv) developing additional steps in the scenarios that would test the adequacy of clearinghouse margin model funds, (v) addressing liquidity concerns, and (vi) conducting reverse stress testing. The report specified that the CFTC "will also explore conducting joint tests with other regulators in the future," which "could broaden the clearinghouses covered or explore the impact of stress scenarios not only on clearing activities but also on other lines of business of the same institutions."

In a recent press release, CFTC Chair Timothy G. Massad remarked that:

These first tests show that clearinghouses had ample resources to withstand extremely stressful market scenarios on the test date. They also show that risk was diversified across clearing members – a loss at one clearinghouse does not mean losses at all.

Commentary / Bob Zwirb

The CFTC staff report celebrates the fact that "[n]o guaranty fund of a clearinghouse registered with the CFTC has ever been used to cover a default." This doesn't tell the whole story, since it was the Fed that came to the rescue during past crises by providing either direct or indirect assistance, which made resorting to the guaranty fund unnecessary.

For example, during the stock market crash in 1987, the Fed intervened in its capacity as lender-of-last-resort in order to provide liquidity to the clearing system. As described by former Fed Chair Ben Bernanke, the principal effect of such loans was to "transfer some trader default risk from the clearinghouses and their members to money-center banks . . . [which] allowed the payments process to begin to normalize; it also restored confidence in the clearinghouse's guarantee of futures contract performance." According to Mr. Bernanke, this action by the Fed "redistributed risks in the system in a socially beneficial way . . . [by providing] ex post insurance to the clearinghouse against a shock that it seemed possible would exhaust the insurance capability of the clearinghouse itself." Ben Bernanke, "Clearing and Settlement during the Crash," Review of Financial Studies, vol. 3, no. 1 at pp. 149-50 (1990).

The CFTC report also lauds the fact that when Lehman and MF Global were found to be in default, no mutualized guaranty fund resources were used. However, as Fed Governor Jerome Powell noted, CCPs might have survived the 2008 financial crisis without direct government assistance, but "many of their major clearing members did receive such assistance." Federal Reserve Board Governor Jerome H. Powell, " Central Clearing in an Interdependent World," FRB Clearing House Annual Conference (Nov. 17, 2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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