This paper looks at non-default losses (NDL) at CCPs and covers who should pay for what types of these losses. The paper also analyses resolution tools for non-default losses and demonstrates each of these tools on the balance sheet of a simplified CCP.
The guiding principle for allocating NDL should be who manages the risk. In line with this principle we propose for the allocation of NDL:
- In order to properly incentivise CCPs to exercise prudent risk management, CCPs and their shareholders should bear almost all NDL, in particular the entire non-default losses related to risks that are exclusively within their control. That is, CCPs should bear all NDL related to:
• operational risks.
• general business risks.
• legal risks.
• cyber risks.
• fraud (or other internal ‘bad acts’).
- In some instances, clearing members and their clients may bear at least a portion of NDL related to custodial risks, settlement bank risks and investment risks. These instances are described in more detail below.
For NDL that a CCP bears itself, the CCP’s parent company and/or equity holders should bear the remaining losses in the event that a CCP’s capital or other dedicated funding is insufficient.
None of the resolution tools we analysed (cash calls, bridge CCP, write-down-and-conversion tool, variation margin gains haircutting) will provide outcomes in line with the no-creditor-worse safeguard, other than the write-down-and-conversion tool, which is very complex and might not always work if initial margin is safeguarded. None of these tools are necessary if CCP equity is sized correctly.
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Documents (1) for CCP Non-Default Losses
ISDA Responds to FCA Consultation on DTO Changes Reflecting USD LIBOR Transition
CCPs, LIBOR, MIFID, Resilience
Industry Papers on CCP Auctions
ISDA Responds to ESMA’s Consultation on CCP Business Reorganization Plans under the CCP Resolution Regime
ISDA Responds to SEC on CCP Governance