OCC, the world’s largest equity-derivatives clearing organization, is collaborating with California Public Employees’ Retirement System and eSecLending to create a source of committed liquidity for OCC while providing a risk-adjusted return for CalPERS.

OCC will include CalPERS in its list of committed lenders along with its existing base of banks and broker-dealers to help ensure that sufficient capacity is maintained at all times, which is critical to central counterparties like OCC.

Expanding its liquidity resource pool to draw on non-bank facilities allows OCC to meet payment obligations to clearing members in a timely way, thus promoting the uninterrupted flow of financial markets.

“This is first and foremost about making sure that counterparties have access to committed liquidity,” John Fennell, vice president of financial risk management at OCC, told Markets Media. “In the event of a financial crisis, and we had a member defaulting, if we were to tap our bank lines, those are the same people that are probably experiencing similar liquidity crunches. Diversifying to an entity that wouldn’t be as pro-cyclical was a real attractive aspect.”

eSecLending, a global securities lending agent, will act as the administrative agent for the facility. “When we started looking at alternative approaches to securing committed liquidity, we engaged eSecLending, and broached the idea of a pension fund providing liquidity because they have a different model,” said Fennell. “They get deposits coming in on a regular basis, and in the event of a financial crisis, pensioners can’t just pull all their money out. They get paid in the regular stream, so it’s a little more predictable.”

Curtis Ishii, head of global fixed income at CalPERS, said in a release: “CalPERS conducted an extensive due diligence process on the facility and are delighted to have established a solution that achieves incremental risk-adjusted returns for our pensioners.”

In analyzing its sources of committed liquidity, OCC concluded that it would be prudent to diversify as a means of providing a backstop in the event of another financial crisis.

“When we started looking at our liquidity, not only the amount we want but also the source, a couple of things stood out,” said Fennell. “Most of our risk already resides with banks as part of our clearing function and also as sources of liquidity, so we were looking for ways to minimize concentration risk from that perspective.”

Under Basel III, a liquidity coverage ratio is being implemented which effectively requires banks to pay capital charges for their commitments.

“What that means is it’s going to be real expensive for banks to be issuing committed lines to clearing houses because their return on just the maintenance is too low to really offset the balance sheet impact,” Fennell said. “We’re expecting that over time access to supply of these lines is going to be diminishing. The cost is going to go up, but we think once Basel III is fully implemented, a lot of those lines won’t even be available to clearing houses at some point.”

Featured image by robert/Dollar Photo Club