The U.S. Commodity Futures Trading Commission held a public meeting of its Market Risk Advisory Committee on Dec. 4 in Washington, D.C. The MRAC discussed, among other issues, clearinghouse risk management, governance and clearing incentives, and explored the challenges of balancing the interests of clearinghouses, their members and end-users. Rostin Behnam, the CFTC Commissioner who oversees this committee, also announced the launch of a subcommittee on interest rate benchmark reform and released a list of the subcommittee members.
The Market Risk Advisory Committee does not have the authority to set rules, but serves as a platform for market participants and other stakeholders to provide input on regulatory issues to CFTC commissioners and staff. The committee consists of representatives from exchanges, clearinghouses, intermediaries and end-users as well as academics and policy experts. FIA was represented by Alicia Crighton, chief operating officer of prime services and U.S. clearing at Goldman Sachs and an FIA board member.
Clearinghouse Risk Management and Governance
The first part of the discussion focused on how clearinghouses manage risks. Speaking on behalf of FIA, Crighton commented that clearinghouses should prioritize market integrity above other interests. "The increase in volumes cleared by CCPs, particularly stemming from the G20 mandate, can lead to enhanced financial stability, but also requires that CCPs engage in strong risk management," Crighton said. "FIA and its clearing members are strong proponents of a healthy and safe clearing system that mitigates systemic risk for the cleared derivatives business."
Crighton also referenced the white paper recently published by FIA, "Central Clearing: Recommendations for CCP Risk Management." That paper is an update to a comprehensive set of recommendations issued in 2015 and covers issues highlighted by recent developments in the industry.
Key topics explored by the MRAC during this discussion included:
Governance: Several MRAC members noted CCPs should undergo regular assessments to ensure transparency and partner in the mutualization of risk with clearing members. Marnie Rosenberg, managing director and global head of clearinghouse risk and strategy at JP Morgan Chase, said members need a "meaningful voice" in CCP risk management protocols. "While employees of some clearing members participate on CCP risk committees, this does not equate to member input into decision making as representatives have varied roles," Rosenberg said.
Direct Clearing: The potential risks of direct clearing, including the September default of a direct clearing member of Nasdaq's Nordic clearinghouse, were addressed several times at the MRAC meeting, However, some MRAC participants noted that self-clearing members come in many different sizes and risk-profiles, and cautioned that rigid prohibitions on direct clearing could in fact harm market integrity. "I don't think self-clearing members are inherently riskier than other clearing members, and we benefit from having them in the ecosystem," said Lee Betsill, managing director and chief risk officer at CME, noted. Crighton discussed FIA's recommendations to help support self-clearing while ensuring proper risk management, including more stringent provisions for direct clearing members in CCP rulebook and risk frameworks, a need for CCPs to look beyond external credit ratings for monitoring membership, and more robust procedures for managing direct-clearing members whose credit profile deteriorates.
Skin in the game: Crighton noted that clearinghouse funds within the default waterfall should "align the interest of CCPs with those of its members" and that skin in the game "should be calculated by reference to the level of risk being managed by a CCP." Although all MRAC participants agreed in principle to the importance of aligning incentives to properly manage risk, how to properly calibrate skin in the game remains up for debate. Kristen Walters, a managing director for risk and quantitative analysis at Blackrock, added that regulatory bodies should get involved by developing a framework for assessing and applying appropriate levels of skin in the game.
Margin Models: There were several detailed discussions regarding ways to increase the efficacy and transparency of margin modeling. Numerous MRAC participants emphasized the need for forward-looking methodologies or more comprehensive views of systemic risk that look beyond surface data sets. For example, Kristen Walters, a managing director for risk and quantitative analysis at Blackrock, commented that margin methodologies for OTC derivatives have been improved in terms of their risk sensitivity, and called for similar improvements for listed derivatives. Dale Michaels, executive vice president of financial risk management at the Options Clearing Corporation added that margin models need to be analyzed as a whole. "When considering the universe of margin models, it is not relevant to compare only one aspect of the model," said Michaels. "Instead, it is necessary to look at the entirety of the margin model."
Incentives to Clear
The MRAC also held a separate panel discussion on recent reports and proposals by global standard-setting bodies that could impact central clearing -- chief among them, appropriate capital treatment for derivatives.
These included a consultative document from Basel Committee on Banking Supervision on leverage ratios, a joint consultation on incentives to centrally clear over-the-counter derivatives by the FSB, Basel Committee, Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions, and a discussion paper on CCP resolution by the Financial Stability Board.
Presenters at the meeting acknowledged that these recent efforts do not necessarily imply changes are on the horizon anytime soon for capital requirements or leverage ratios that can create disincentives to clearing. However, Robert Wasserman, chief counsel of the CFTC's division of clearing and risk, urged MRAC members to treat recent requests for comments as "an opportunity" in the long-term quest for improvements.
"Substantial progress has been made in that the door is at least partially open. For those of us who look at things from a legal perspective, asking a question in a proposal means that answers to that question could be part of the logical outgrowth of that proposal," Wasserman said. "You might well benefit by submitting responses that demonstrate a willingness to engage."
For its part, FIA has continually advocated for more equitable leverage ratio calculations and continues to consult with global standard-setting groups on capital requirements.
Interest Rate Benchmark Reform Subcommittee
Also at the meeting, Rostin Behnam, MRAC's sponsoring commissioner, introduced a recently appointed Interest Rate Benchmark Reform Subcommittee. The subcommittee is intended to "complement" the work of the existing Alternate Reference Rates Committee created by the Federal Reserve and assist the ARRC in its efforts to help market participants transition from U.S. dollar LIBOR to SOFR, the Secured Overnight Financing Rate, as the basis for interest rate futures and derivatives.
Chaired by Thomas Wipf, vice chairman of institutional securities at Morgan Stanley and a member of the ARRC, the 21-member subcommittee includes asset managers, clearinghouses, swap execution facilities, trade associations, market makers and a variety of other market participants. A full list of members is available here.
The subcommittee will offer "insight into the potential challenges leading up to the 2021 end of compelled LIBOR, identifying the risks for financial markets and individual consumers, and, above all else providing solutions within the derivatives space," Behnam said.
The subcommittee will meet in January and monthly thereafter, and report recommendations back to the broader MRAC. Wipf explained that the subcommittee is preparing to make specific and actionable proposals for policy changes that will remove hurdles to the transition to SOFR and incentivize market participants to make that transition.