Central counterparty exposure in stressed markets

Focus

We propose a new way of monitoring the risk exposure of a central counterparty (CCP) towards its clearing members, ie "CCP exposure". We track and break down changes in CCP exposure into price- and position-related factors. We study how these factors interact under stressed market conditions, ie when CCP exposure is at a high level or undergoes a large and abrupt increase. In addition, we examine which of the members' accounts feature most prominently in shaping the total exposure in these circumstances: the house accounts, which tend to conduct leveraged trades and have little loss-absorbing capacity, or client accounts, where losses are more easily absorbed.

Contribution

We contribute to a rapidly expanding literature on central clearing by proposing an approach to monitoring CCP exposure intra-daily. This approach is particularly useful in stressed markets, when trading is fast-paced and data come in rapidly. Our approach copes with such "big data" challenges and, in particular, sheds light on how the commonality of exposures across clearing members increases a CCP's overall exposure in stressed markets.

Findings

We find that the drivers of a CCP's overall exposure in stressed markets are fundamentally different from those in normal times.

For the first set of findings, we consider changes in CCP exposure. When these changes are of a typical size, they reflect almost entirely changes in the trading positions of clearing members. However, extremely large increases in CCP exposure tend to stem either from a spike in the volatility of security returns or from higher commonality of the exposures due to similar trading strategies, ie "crowding".

Second, we consider the level of CCP exposure. Again, we find that - in contrast to normal times - high levels stem mostly from crowding. More specifically, at times of market stress, the bulk of CCP exposure is concentrated in a few clearing members and a small set of risk factors.

Third, we find that the share of house accounts in CCP exposure remains roughly the same in stressed as in normal times. However, a larger share of the total house-account exposure stems from just a few clearing members.

Abstract

Time is valuable, particularly in stressed markets. As central counterparties (CCPs) have become systemically important, we need to understand the dynamics of their exposure towards clearing members at high frequencies. We track such exposure and decompose it, yielding the following insights. The composition of CCP exposure is fundamentally different in the tails. At extreme levels or during rapid increases, there is elevated crowding. This is the result of clearing members all concentrating their positions on a single security or a particular portfolio, which is desirable if motivated by hedging but worrying if due to speculation.

JEL codes: G10, G23, G20

Keywords: central counterparties (CCPs), crowding risk, market stress