CFTC’s Massad Parses Clearing Risk

Terry Flanagan

Issues related to clearing of OTC derivatives must be viewed from the perspectives of all interested participants, including end users, regulators, futures commission merchants, and the clearinghouses themselves, CFTC chairman Timothy Massad said in the keynote speech at FIA Boca on Wednesday.

“As we engage in this public discussion about clearinghouse risk, we should always remember to look at the full picture – that is, to look at all the regulatory policies, the clearinghouse practices, the oversight, and the sum of activities that contribute to rigorous risk mitigation,” Massad said. “We should not focus on one particular issue without considering how it connects to other issues.”

An example of the importance of looking at the full picture is risk mitigation through the collection of initial margin. There has been some focus on one issue in particular, which is the liquidation period – that is, whether a clearinghouse should assume a one-day, two-day, five-day, or other minimum time horizon for its ability to liquidate a particular product.

“This is an important issue,” said Massad. “Indeed, our regulations require that the time period must be appropriate based on the characteristics of a particular product or portfolio. But the minimum liquidation period is only one of the many issues that affect how much initial margin is posted with the clearinghouse.”

The amount of margin a clearinghouse holds will also depend on whether clearing members post margin on a gross or net basis, Massad said. “Net” means a clearing member can net customers’ positions to the extent they offset one another, which reduces the amount of margin that must be sent to the clearinghouse for the overall portfolio. By contrast, “gross” posting means the clearing member must post for each customer, without any offsets across customers, which means the clearinghouse receives more – in many cases, much more – collateral than under net posting.

The CFTC has come out with proposed rules on margin for uncleared derivatives. The rules would require two-way margin (posting and collecting) for all trades between swap dealers and financial end users that have over $3 billion in gross notional exposure in uncleared swaps. IM requirements would be phased-in starting Dec 1, 2015 and ending Dec 1, 2019 from the largest participants to smaller ones.

Massad said that the CFTC “will be continuing to look at the full range of issues pertaining to clearinghouse risk, resiliency, recovery, and resolution,” including working with CPMI-IOSCO to develop clearinghouse stress testing and recovery policies, as well as with the Financial Stability Board’s Resolution Steering Group.

“While no one wants to get to resolution, it is important that we explore how this would be done as well, without a government bailout and without creating contagion,” he said. “We should always take a comprehensive approach to these issues, one that is based on a clear understanding of risk, that enhances transparency and market integrity, and that is backed up by rigorous, ongoing oversight. Effective risk mitigation and resiliency require a broad range of policies and procedures.”

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