Central Counterparties (CCPs) within the European Union (EU) are resilient to stress scenarios, according to the first stress test conducted by the European Securities and Markets Authority (ESMA), the results of which were published last week. The test showed that CCPs have enough resources to cover losses resulting from the default of the top-two EU clearing members (CMs) groups combined with historical and hypothetical market stress scenarios.
However, under more severe stress scenarios, CCPs faced small amounts of total residual uncovered losses varying from €0.1 billion up to €4 billion.
When talking about severe stress scenarios, the ESMA report refers to such assuming the default of the top-two CMs per CCP due to assumed CM defaults across CCPs. That is a scenario where a CM defaulting in one CCP would also be considered to be in default in all CCPs, in which it is a member, leading to more than 25 CM defaulting EU-wide.
The ESMA tested the resilience of a total of 17 EU CCPs with more than €150 billion in default resources and with more than 900 CMs. For the purpose, the regulatory body used combinations of CM default and market stress scenarios. The stress test used data from the end of 2014 provided by the National Competent Authorities (NCAs) and the European Systemic Risk Board (ESRB).
- of the two CMs with the largest exposures per CCP, taking into account the common membership across CCPs;
- the default of the two groups of CMs EU-wide with the largest aggregate exposures; and
- the default of the two groups of CMs EU-wide with the largest aggregate exposures weighted by their probability of default.
The regulator will conduct such tests annually, as required by the European Market Infrastructure Regulation (EMIR), again in cooperation with the NCAs and the ESRB.
“CCPs play a significant role in financial markets by reducing the exposure risk of clearing members. Therefore, ensuring that CCPs are resilient to shocks is an important supervisory tool to mitigate systemic risk. ESMA’s first EU-wide stress test shows that European CCPs are overall well equipped to face the counterparty risk associated with the considered stress scenarios,” said ESMA Chairman Steven Maijoor. “However, ESMA has also issued recommendations addressed to the National Competent Authorities (NCAs) of CCPs. These recommendations are aimed to ensure on-going resilience which will require follow-up within CCP colleges,” he added.
Based on the results of the stress test, ESMA composed the following recommendations for EU CCPs:
- assessment of the creditworthiness of CMs – a significant part of CCPs collateral are pooled resources of non-defaulting CMs. In extreme cases, these CM could face significant losses which in turn could trigger the default of further CMs and additional losses at CCP level. Therefore, ESMA recommends that CCPs incorporate in their creditworthiness assessment of CMs, the potential exposures these may face due to their membership in other CCPs. Such analysis is essential in order to identify sources of increased exposure; and
- methodologies for price shocks – in the course of data analysis provided by CCPs, ESMA has also identified that in a number of cases the stress price shocks applied by CCPs for some of their cleared products as part of their own stress testing framework are not as conservative as theminimum shocks defined for this exercise or do not replicate the most extreme historic price changes observed. To achieve the on-going resilience of CCPs, ESMA recommends NCAs to ensure that CCPs revise their price shocks used in their stress test methodologies where gaps have been identified in the course of the exercise.
The ESMA is an independent EU authority that directly supervises and safeguards the EU financial markets. It has established a single rulebook for EU financial markets and promotes the convergence of the regulatory bodies of EU countries. In addition, it also assesses risks to investors, markets and financial stability.
In the EU, a financial service license issued by any member state applies to the markets of all other EU countries. However, in case of misconduct entities are supervised and penalized by the authorities under which regulation they fall. EU forex brokers predominately choose to be regulated in Cyprus or the UK.