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.