December 21, 2017/Fitch Ratings
Increasing exposure to clearing houses and central counterparties (CCPs) may in time attract more regulatory oversight and scrutiny, according to Fitch Ratings in its latest North American Financial Institutions Chart of the Month.
The world’s major clearing houses have benefitted from a generally supportive regulatory environment that has created incentives for market participants to clear transactions centrally as opposed to over-the-counter on a bilateral basis. While this has boosted growth for CCPs, it has also resulted in a steady increase of market participants’ exposures to the CCPs.
The results of the recent regulatory stress tests published last month by the U.S. CFTC demonstrated that the world’s largest CCPs generally have adequate liquidity resources to complete their end-day settlements should a severe but plausible market stress take place. ESMA has performed a similar exercise as a part of its 2017 stress testing of EU CCPs with the results expected to be published early into 2018.
“Regulatory stress tests are an important and standardized measure of CCPs’ resilience, but the tests incorporate the use of committed credit lines that could be extended by commercial banks, which may be also CCPs’ largest clearing members,” said Evgeny Konovalov, Director in Fitch’s Financial Institutions group.
CCPs’ allocated own capital resources, commonly referred to these days as ‘skin in the game’, remain relatively small for the majority of the world’s largest players. Larger ‘skin in the game’ would be positive for CCPs’ risk profiles as it would improve alignment of interest between CCPs’ shareholders and clearing participants. This would in turn maintain margin and counterparty standards in an increasingly competitive environment.
An area to watch in 2018 will be the implementation of MIFID II/MIFIR requirements for open and non-discriminatory access to trading venues and CCPs. These provisions may pose a challenge to national CCPs’ currently well-entrenched franchises and lead to a re-distribution of clearing volumes to the larger international CCPs.
Brexit may also have implications for CCPs. In a ‘hard Brexit’ scenario, EU regulators may demand direct oversight over the clearing of euro derivatives, which would complicate cross-border supervision of CCPs. Forced relocation of euro clearing is also possible but considered less probable by Fitch, given the potential market disruption such a move could cause.
Despite these challenges and uncertainties, Fitch’s 2018 outlook for financial market infrastructure companies, including CCPs, is stable, taking into account CCPs’ ample liquidity, robust risk management frameworks and a generally supportive regulatory environment.