The Commodity Futures Trading Commission held a public meeting today to discuss guidance recently issued by CPMI-IOSCO on clearinghouse resilience and recovery (see FIA Special Alert issued on Aug. 17).
The meeting was one of several that regulators are holding around the world to gather feedback on the guidance, which is due to be finalized early next year. The deadline for commenting on the guidance is Oct. 18.
The CFTC discussion focused primarily on four main issues: stress testing, margin, governance and "skin in the game," the term used to refer to the financial resources that come from the clearinghouses themselves, rather than members or customers.
The participants in the CFTC meeting, who represented clearinghouses, banks and asset managers, generally praised the proposed standards and offered suggestions for improvements. The most widely supported recommendations were to require clearinghouses to provide more transparency into their risk management practices and to avoid setting margin standards that create "pro-cyclical" effects during a period of market stress.
The biggest controversy was over the skin-in-the-game issue, with clearinghouses pushing back on suggestions from clearing firms and asset managers that they should be required to post more of their own capital. There were also differences of opinion over the role of a clearinghouse's board of directors. While the participants agreed that boards need to play a greater role in oversight, clearing members said the board should get more involved in risk management, while clearinghouses said the boards should not be involved in day-to-day decision making.
Governance
Participants agreed that the proposed guidance should clarify the responsibility of clearinghouse risk committees. Representatives of clearinghouses and clearing firms said the risk committee members are there to provide expertise on issues affecting the safety of the clearinghouse, rather than representing the commercial interests of the member firms. They also urged the regulators to allow risk committee members to consult with experts within their firms. In addition, several participants urged the regulators to require clearing houses to establish some sort of mechanism separate from the risk committee for gathering input from the full range of stakeholders. Furthermore, the responsibilities of board members should cover all material risks, rather than just margin and stress testing, one clearing firm representative recommended.
Margin
CFTC staff asked if a minimum standard should be set for the "margin period of risk," the term used for the amount of time used to calculate margin requirements. This is typically one or two days for futures and five days for cleared swaps. Clearing firms said there were a number of factors that impact what the appropriate MPOR should be, and it will therefore differ by product.
Most participants called for greater disclosure of margin methodologies so that members and customers can anticipate margin calls. Most participants also called for measure to avoid pro-cyclicality, for example, by setting "floors" to avoid setting margin requirements too low during a period of low volatility.
Several clearing firm representatives said the margin methodology should be based on “defaulter pays”, meaning that the level of initial margin for each position should be set high enough to cover the risk exposures posed by that position. They also recommended that that the standards discourage clearinghouses from allocating customer risk to their clearing members through ad-hoc charges that are not part of the default waterfall.
The clearinghouse representatives urged regulators to take a principles-based approach to margin requirements, rather than writing detailed rules with prescriptive requirements. Several clearing firm representatives challenged this, however, pointing to the problems caused by the practice of "one-way" margin calls, with the clearinghouse collecting margin but not paying out. The clearing firm representatives also questioned the use of intraday margin calls during the Brexit turmoil in June, saying that such a large jump in margin requirements indicated flaws in margin models.
Asset managers reiterated their concerns about "variation margin gains haircutting," meaning the potential that a non-defaulting customer might not receive the full amount of their variation margin gains if some of those gains are used to cover losses. The asset managers emphasized that this resource should not be used to cover losses except in extreme situations, and only in the context of a clearinghouse resolution. In response, a clearing firm representative argued that while VMGH is not a good outcome, it would be the "least bad option" available to avoid moving the clearinghouse into resolution.
Stress-Testing
Most participants argued that clearinghouses should be required to provide more disclosure about the results of their stress testing. They added that stress testing scenarios should take into account the interconnectedness of their clearing members with their liquidity providers, i.e., the banks that provide them with credit. Stress testing scenarios also should take into account the possibility that client positions will not be ported out of a defaulting clearing to another clearing firm.
Liquidity Risk
Two clearinghouse representatives called for the Fed to provide them with access to credit facilities and repo facilities, saying this would alleviate the risk that the banking system would not be able to provide them with liquidity during a period of market stress.
Skin in the Game
Asset manager and clearing firm representatives emphasized the need for requirements in this area, saying skin in the game is a way to ensure "robust" risk management at clearinghouses. The clearinghouses pushed back on this argument, however, saying that they should not be obliged to cover the risks being brought to the clearinghouse by the members and their customers. The asset managers disagreed, saying that that skin in the game is an effective tool for ensuring that clearinghouse owners bear losses as well as gains.
