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Rearranging risk 

October 14, 2015

Banking Tech

The regulatory drive to move as many products as possible to central clearing is putting greater pressure on central counterparties (CCPs) than ever before and in turn increasing systemic risk in the market. At present, bilaterally cleared products in the over the counter (OTC) market represent a medium risk of default and a medium impact if a bank defaults. Central clearing, however, represents a lower risk of default but a much greater impact if there is a default.

The most recent clearing house failure was the Hong Kong Futures Exchange in 1987. The effects were devastating. The Futures Exchange had to close, followed by the stock market. Reopening the market was no small feat. World markets had fallen further in the meantime, so there was a risk that a modestly ‘recapitalised’ clearing house would go broke again if positions had to be marked down immediately. In the event, the Hong Kong Government and the clearing banks underpinned the clearing house. Lessons have been learned and this has given rise to the status of systemically important financial market utilities (Sifmus).

The growing importance of CCPs has put issues such as CCP governance, resilience and recovery firmly in the spotlight. The Depository Trust & Clearing Corporation (DTCC) operates two CCPs, the Fixed Income Clearing Corporation (FICC) and the National Securities Clearing Corporation (NSCC), both of which have been designated as Sifmus. In June, DTCC published a white paper, CCP Resiliency and Resources, outlining its views on CCP governance, stress testing, default management and continuity of CCP services in times of market distress.

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