GLOBAL – A new report released by the International Swaps and Derivatives Association (ISDA) has warned against the potential contagion risk entailed by clearing houses – also called central counterparty (CCPs) – if one clearing member were to default in the centrally cleared derivatives chain.
ISDA's concerns echo those of Dutch asset manager APG, which warned of the potential risk of clearing member default last year.
The asset manager was at the time opposed to the clearing model set out under the European Market Infrastructure Regulation (EMIR), arguing that it would push pension funds to take on "huge" exposures to clearing members.
In its report, ISDA warned of the impact the default of a clearing member could have on CCPs themselves, stressing that regulatory frameworks around the globe currently failed to capture the risk of multiple clearing members defaulting not only on one CCP, but across all CCPs on which the member clears derivatives trades.
"A drawback of regulatory [and other methods] that are currently proposed is that they consider exposure to each CCP in isolation, and do not consider cross-CCP risk," ISDA said.
"They also do not consider that a clearing member has simultaneous exposure to all of the CCPs on which it clears and thus that exposures should not be capitalised to each on a standalone basis."
The association therefore called on the introduction of a new calculation method, which would consist in incorporating a Historic Drawdown Measure (HDM) into an incremental default risk, which is the type of model that is currently used for calculating the default risk.
This, according to ISDA, would enable policyholders to recognise that when a clearing member defaults, it does so on the multiple CCPs simultaneously.
Under the central clearing system, a pension fund or asset manager deals with the CCP via a clearing member, usually a prime broker or a bank.
A clearing member often clears on various CCPs at the same time and does not necessarily trade with one clearing house only.
To date, the CCP model has not been required to recognise the risk profile of each separate client. Pension funds have therefore argued that they have been pushed to take credit risk on clearing members with a much lower creditworthiness.
Talking to IPE last year, APG chief legal counsel Guus Warring said: "One of the reasons why we are opposed to the current EMIR requirements is that pension funds run a huge exposure to those clearing members, which are the banks themselves."