2021–22 CCP Supervisory Stress Test: results report

Results of the Bank of England's 2021-22 Supervisory Stress Test of Central Counterparties
Published on 13 October 2022

1: Foreword

The conclusion of the Bank of England’s (Bank’s) first public Central Counterparty (CCP) Supervisory Stress Test (SST) marks a major milestone in the development of the Bank’s CCP Supervisory Stress-Testing regime, of our supervision and regulation of CCPs, and in the attainment of the Bank’s broader financial stability objectives.

UK CCPs are large and complex, and sit at the centre of the UK and global financial system. Their resilience is a global public good. Market volatility over the past year has demonstrated how important the resilience of the UK clearing network is to financial stability in the UK and abroad.

Supervisory stress tests have an important role to play in assessing resilience, providing transparency and promoting confidence. The stress-testing methodology that the Bank is developing allows us to explore a wide range of risks to UK CCPs, and test their resilience under a multitude of extreme circumstances. It enables the Bank to deploy a series of innovative approaches to examining risks at individual CCPs and across the UK clearing network.

The 2021–22 CCP SST is the first test of this kind that the Bank has carried out and is exploratory, with no pass-fail assessments. The results confirm the resilience of the UK CCPs to market stress scenarios that overall are of equal and greater severity than the worst historical market stresses. Each UK CCP has sufficient prefunded financial resources to absorb losses arising from the default of numerous different combinations of Clearing Members – from the largest pair to a more numerous combination of smaller entities – in a severe market stress scenario at the limits of historical experience. Further, in this same market stress scenario, each CCP maintains a positive liquidity balance under the default of the Cover-2 population. By intentionally testing CCPs against stress events more severe than historical precedence or regulatory requirements – so called ‘reverse stress tests’ – the Bank has enhanced its understanding of CCP resilience and what would be required to deplete CCPs’ financial resources. This information will help the Bank target its supervision and CCPs focus their risk management.

The findings from this exercise will inform the Bank’s ongoing supervisory and regulatory work, at both the domestic and international level. The Bank will continue developing its stress-testing framework, building on the experience gained in the 2021–22 test for the development of our next text. We will publish our CCP stress-testing framework during the course of 2023.


Sir Jon Cunliffe, Deputy Governor Financial Stability

2: Executive summary

In October 2021, the Bank announced the launch of the 2021–22 Supervisory Stress Test (SST) of UK Central Counterparties (CCPs) (the 2021–22 CCP SST). This exercise is the Bank’s first public CCP SST, and follows the Bank’s (non-public) pilot CCP SST exercise in 2019, the publication of the Bank’s Discussion Paper on Supervisory Stress Testing of Central Counterparties, and the Bank’s participation in the European Securities and Markets Authority’s (ESMA) EU-wide CCP Stress-Test exercises.

Purpose and design

This exercise is exploratory in nature. It aims to identify potential vulnerabilities and gaps in CCP resilience, rather than testing CCPs against particular pass-fail thresholds. The findings will be used to support and inform the Bank’s supervisory and regulatory activities. The lessons from running this exercise will also be used to support the continued development of the Bank’s framework for CCP supervisory stress testing, in conjunction with the feedback received on the Bank’s Discussion Paper on Supervisory Stress Testing of Central Counterparties.

The 2021–22 CCP SST exercise was launched in October 2021. It explores the individual and system-wide credit and liquidity resilience of the three UK CCPs (ICE Clear Europe Limited (ICEU), LCH Limited (LCH), and LME Clear Limited (LMEC)) and each of their Clearing Services. In particular, the impact on CCPs’ financial and liquidity resources is examined under a combined baseline severe financial market stress scenario (the ‘Baseline Market Stress Scenario’) plus the simultaneous default of selected Clearing Member groups (including in their capacity as service providers). The selected Clearing Member default scenarios include, but are not limited to, the default of the Cover-2footnote [1] population at each CCP Clearing Service. The exercise also explores the impacts of this Baseline Market Stress Scenario and the default of certain groups of Clearing Members on the non-defaulting Clearing Member and client populations at the UK CCPs.

The Baseline Market Stress Scenario consists of shocks to the prices of a wide range of products cleared by the UK CCPs. It is calibrated to be broadly equivalent in overall severity to the worst historical market stress scenario for each UK CCP Clearing Service (as at the time of the launch of this exercise in October 2021). This scenario does not – and cannot – cover all possible sizes and combinations of market price shocks to which CCPs could be exposed. For example, the scenario is not focused on large hypothetical shocks that go far beyond historical limits in specifically selected asset classes or products.

In addition, sensitivity analysis and reverse stress-testing techniques are used to test CCP resilience against increasingly conservative assumptions. Reverse stress testing is used to evaluate CCPs’ resilience to increasingly challenging combinations of assumptions that are intentionally well beyond historical precedence and regulatory requirements,footnote [2] and in combination are extremely severe. This includes an examination of CCP resilience against additional market stress scenarios that overall are more severe than those historically observed and contain individual market shocks greater than historically observed for a variety of products.

The analytical components of the 2021–22 CCP SST are explained in Section 3 and summarised in Figure 1.

Results and findings

Overall, the UK CCPs are resilient to the Baseline Market Stress Scenario and simultaneous default of the Cover-2 population, from both a credit and liquidity perspective. In the Credit Stress Test component of this exercise, none of the UK CCPs’ Clearing Services experience full depletion of prefunded financial resources.footnote [3] Similarly, in the Liquidity Stress Test component of this exercise, no UK CCP experiences a negative liquidity balance at any point in the five-day stress-test window under the central assumptions, either at an aggregate currency level or either pound sterling (GBP), US dollar (USD) and euro (EUR).

Credit Stress Test

In the Baseline Market Stress Scenario, none of the UK CCPs’ Clearing Services experience full depletion of prefunded financial resources. However, results vary significantly across the CCPs and their Clearing Services. For some Clearing Services defaulting Clearing Members’ own resources are sufficient to meet losses, without drawing on the Default Fund. Other Clearing Services experience low or moderate depletion of prefunded resources. For one CCP Clearing Service (LME Base), losses result in close to full depletion of the Default Fund when the Bank’s estimates of concentration costs are included.footnote [4]

Prior to the conclusion of the 2021–22 CCP SST, there have been very large shocks in the price of nickel – outside of historical experience – resulting in a very severe stress for LME Base in March 2022. The Bank has launched a review (including the use of a skilled person review) into the operation of LMEC during March 2022, to determine what lessons might be learned in relation to its governance and risk management.footnote [5]

The Credit Stress Test results also show that the degree of resilience of most CCP Clearing Services is sensitive to assumptions regarding CCPs’ ability or inability to successfully transfer (port) client accounts at defaulting Clearing Members to non-defaulting Clearing Members. While porting successfully during a default event may be challenging, the results show there are material benefits if porting can be executed effectively at Clearing Services where client clearing represents a greater share of clearing activity. For some Clearing Services, these benefits are observed when segregated client accounts are assumed to successfully port, while for others they arise when all client accounts (including gross and net omnibus accounts) are assumed to successfully port. The recently published CPMI-IOSCO report, ‘Client clearing: access and portability’, set out a range of potentially effective porting practices, and called for development of further effective practices to facilitate porting. The Bank intends to continue analysis and exploration of porting in future CCP supervisory stress tests, as well as through other regulatory activities.

Credit Reverse Stress Test

In the Credit Reverse Stress Test, CCPs are subjected to an increasingly challenging combination of assumptions to identify what might fully deplete their prefunded and non-prefunded resources. These assumptions are intentionally well beyond historical experience and regulatory requirements, and in combination are extremely severe.

No CCP Clearing Service experiences a full depletion of both prefunded and non-prefunded resources in the Standard Credit Reverse Stress Test in which CCPs are subject to market stress scenarios with a level of severity that goes increasingly beyond the worst historical market stress scenarios, and an increase in the number of defaulting Clearing Member groups (up to five).

Full depletion of both prefunded and non-prefunded resources occurs only under an extreme combination of assumptions, and then only for two CCP Clearing Services (LME Base and LCH SwapClear). This occurs under a combination of market stress scenarios and/or Clearing Member group default assumptions that go beyond historical precedents and regulatory requirements as well as, further to this, the inclusion of conservative estimates of concentration costs.

LCH SwapClear only experiences full depletion of prefunded and non-prefunded resources under a combination of these concentration costs, the simultaneous default of at least the three Clearing Member groups with the largest stressed losses over defaulting members’ resources, and a market stress scenario materially more severe than historically observed. LME Base only experiences full depletion of prefunded and non-prefunded resources under: (i) a combination of these concentration cost estimates, the simultaneous default of at least the four Clearing Member groups with the largest stressed losses over defaulting members’ resources, and a market stress scenario of similar severity to the worst historically observed market stress scenario for LME Base; or (ii) a combination of these concentration cost estimates, a Cover-2 default, and a market stress scenario materially more severe than historically observed.

Liquidity Stress Test

The Liquidity Stress Test shows that all three CCPs maintained a positive liquidity balance at the aggregate currency and individual currency level for key currencies (EUR, GBP and USD). This exercise also includes both sensitivity testing of the Liquidity Stress Test results and an analysis of the concentration of CCPs’ activity in three different types of service provider (payment banks, investment agents and custodians).

The Liquidity Sensitivity Testing examines the impact of disruption to CCPs’ ability to mobilise their liquid resources. The results vary across CCPs. For example, LCH is significantly impacted, and has a negative liquidity balance at the aggregate currency level, if unable to liquidate non-cash collateral in the market. Similarly, LMEC has a negative liquidity balance at the aggregate currency level if unable to access resources under management of the defaulting investment agents. However, in reality, CCPs have specific tools and measures available to manage these dependencies, including access to the Bank’s Discount Window Facilityfootnote [6] and ability to revoke investment agents’ powers of attorney and mobilise their funds via alternative arrangements.

From a liquidity management perspective, the results show that the provision of key services that CCPs rely on for liquidity risk management are concentrated across a small number of payment banks, investment agents and custodians. Furthermore, these services are often performed by entities belonging to the same Clearing Member groups. While this concentration may be driven by Clearing Member preferences and market-related factors, these results demonstrate the importance of ensuring sufficient operational soundness of CCPs’ arrangements with service providers, ability to address service provider disruptions, and CCPs’ ongoing monitoring and testing of Clearing Members’ back up arrangements. The Bank will continue to keep these arrangements under review, including as part of future exercises.

Clearing Member and Client Analysis

The 2021–22 CCP SST exercise also includes an examination of the impact of the Baseline Market Stress Scenario and Clearing Member default scenarios from the perspective of the non-defaulting Clearing Member and client population at the UK CCPs. From a credit stress perspective, the exercise includes an examination of the impact on non-defaulting Clearing Members through depletion of their contributions to CCPs mutualised Default Funds. From a liquidity stress perspective, the exercise included an examination of the liquidity demands on Clearing Members through the Variation Margin calls in the Baseline Market Stress Scenario.

The results show that credit and liquidity demands are likely to be greatest for the largest financial groups. However, based on publicly available information and regulatory disclosures, these demands appear to be manageable in the context of those Clearing Members’ resources. Non-bank Clearing Members also face large Variation Margin calls, and the stress-test results show that the default of these (and other) non-bank Clearing Members can lead to mutualised losses at CCPs. It is therefore important that CCPs are fully assured of the ability of all of their Clearing Members, especially non-banks, to meet potential liquidity needs in a stress, including via due diligence and membership criteria.

These findings support the conclusions of the BCBS-CPMI-IOSCO Review of margining practices,footnote [7] for which the next steps include further international work to enhance the transparency of stressed margin calls and enhance liquidity preparedness of the Clearing Member and client population.

Next steps

Following the conclusion of the 2021–22 CCP SST exercise, the Bank intends to publish a framework document for CCP supervisory stress testing during the course of 2023. This framework will draw on the feedback received on the Bank’s Discussion Paper on Supervisory Stress Testing of Central Counterparties as well as the experiences and lessons learned from the 2021–22 CCP SST exercise. The Bank will also launch its next supervisory stress test in due course.

3: Introduction

On 19 October 2021, the Bank announced the launch of the 2021–22 CCP SST. This exercise is the Bank’s first public CCP SST, and follows the Bank’s (non-public) pilot CCP SST exercise in 2019, the publication of the Bank’s Discussion Paper on Supervisory Stress Testing of Central Counterparties, and the Bank’s participation in the European Securities and Markets Authority’s (ESMA) EU-wide CCP Stress-Test exercises.

Objectives

As set out at the launch of the 2021–22 CCP SST, the exercise is exploratory in nature. It is not aimed at checking compliance with regulations, assessing CCPs’ internal stress tests, or testing CCPs against particular pass-fail thresholds. Rather, the exercise aims to identify potential vulnerabilities and gaps in CCP resilience, with the findings used to support and inform the Bank’s supervisory and regulatory activities.

The findings and lessons from running the 2021–22 CCP SST exercise will also be used to support the continued development of the Bank’s framework for CCP supervisory stress testing. This will be in conjunction with the feedback received on the Bank’s Discussion Paper on Supervisory Stress Testing of Central Counterparties.

A key objective of this exercise is to explore the individual and system-wide credit and liquidity resilience of the three UK CCPs (ICE Clear Europe Limited, LCH Limited and LME Clear Limited). In particular, the 2021–22 CCP SST examines the impact of a severe market shock and the default of selected Clearing Member groups (including in their capacity as service providers) on CCPs’ resources. These severe market shock scenarios include a Baseline Market Stress Scenario plus three additional market stress scenarios used for sensitivity analysis and reverse stress testing (see Section 4). The selected defaulting Clearing Member groups includes the default of the Cover-2 population at each CCP Clearing Service, but also other separate combinations of defaulting Clearing Members.

The exercise also includes an examination of the impact of the 2021–22 CCP SST Baseline Market Stress Scenario and default assumptions from the perspective of Clearing Members and clients. In particular, the exercise includes an analysis of the liquidity demands on Clearing Members and clients, as well as the potential allocation of losses over defaulters’ resources to non-defaulting Clearing Members through CCPs’ Default Waterfalls.

Participation

All of the three UK authorised CCPs participated in the 2021–22 CCP SST exercise (ICEU, LCH and LMEC).

All of the Clearing Services of the three UK authorised CCPs at the time of the launch of the 2021–22 CCP SST exercise were in scope. These Clearing Services cover a broad range of financial market products. The LME Precious Clearing Service has subsequently closed since the launch of the 2021–22 CCP SST, so results for LME Precious are not presented in this report. footnote [8]

Table A below details these Clearing Services and the key products cleared in each of these Clearing Services.

Table A: UK CCP Clearing Services

CCP

Clearing Service

Key products cleared

LCH Limited (LCH)

SwapClearfootnote [9]

Interest rate swaps

RepoClear

Repos (UK Gilts collateral)

EquityClear

Equities

ForexClear

Non-deliverable and deliverable FX

ICE Clear Europe Limited (ICEU)

Futures and Options (F&O)

Commodities, equity derivatives, fixed Income

CDS

Credit

LME Clear Limited (LMEC)

LME Base

Commodities (base metals)

LME Precious

Commodities (precious metals)

Analytical components

The 2021–22 CCP SST exercise consists of four core analytical components: the Credit Stress Test, the Credit Reverse Stress Test, the Liquidity Stress Test, and the Clearing Member and Client Analysis (Figure 1). The analysis for each is undertaken using a Baseline Market Stress Scenario, detailed in Section 4. Three additional market stress scenarios, also detailed in Section 4, are utilised for the purpose of the Credit Reverse Stress Test.

Section 5 covers the Credit Stress Test. The purpose of the Credit Stress Test component is to examine the combined impact of the Baseline Market Stress Scenario plus the simultaneous default of a given population of Clearing Member groups on CCPs Clearing Services’ financial resources, and assess their ability to absorb default losses within their respective Default Waterfalls.footnote [10]

Section 6 covers the Credit Reverse Stress Test. The purpose of the Credit Reverse Stress Test is to identify what might fully deplete CCPs’ prefunded and non-prefunded resources CCPs by subjecting them to increasingly challenging combinations of assumptions. These combinations of assumptions on market stress severity, number of defaulting Clearing Member groups, and concentration costs are intentionally well beyond historical precedence and regulatory requirements, and in combination are extremely severe.

Section 7 covers the Liquidity Stress Test. The purpose of the Liquidity Stress Test is to examine the impact of the combined Baseline Market Stress Scenario plus the simultaneous default of the Cover-2 population (including in their capacity as service providers)footnote [11] on CCPs’ liquid resources and their ability to meet their liquidity requirements. The Liquidity Stress Test component also includes an analysis of the provision of key services that CCPs rely on for liquidity risk management (Box B).

Section 8 covers the Clearing Member and Client Analysis. The Clearing Member and Client analysis is undertaken to examine the impacts of the Baseline Market Stress Scenario on Clearing Members and Clients of the UK CCPs. This analysis includes an examination of potential liquidity demands on Clearing Member and Client accounts, and Clearing Members’ exposures to potential losses through the mutualised Default Fund contributions across all CCP Clearing Services.

Section 9 summarises the conclusions of the 2021–22 CCP SST exercise, and details next steps regarding the development of the Bank’s framework for CCP supervisory stress testing.

Annexes contain additional results, charts and graphs referred to in the report.

Figure 1 summarises the analytical components and sub-components of the 2021–22 CCP SST exercise, detailed further in each components’ respective section.

Figure 1: Summary of the 2021–22 CCP SST analytical components

Figure 1 illustrates the components of the 2021-22 CCP SST, described further in the introduction and relevant sections of the report.

4: Market Stress Scenarios

The analysis in each of the Credit Stress Test, Liquidity Stress Test, and Clearing Member and Client analysis is based around a Baseline Market Stress Scenario. This Baseline Market Stress Scenario is also the starting point for the Credit Reverse Stress Test.

The Baseline Market Stress Scenario is a theoretical scenario produced by the Bank. It consists of shocks to the prices of a broad range of products cleared by the UK CCPs (see Table A above), rather than being concentrated in a small number of asset classes or products. In total, it includes two-day and five-day shocks to 119 individual market prices (or risk factors). The specific two-day and five-day shocks to each risk factor are detailed in Annex A.

The Baseline Market Stress Scenario represents a global ‘risk-off’ scenario, in which interest rates and government bond yields increase across most currencies and maturities, prices decline for the vast majority of commodity products, equity prices and equity indices decline, CDS spreads widen, and emerging market currencies depreciate.

In designing the Baseline Market Stress Scenario, the direction of – and relationship between – market shocks was grounded in historically observed shocks aligned to the overall ‘risk-off’ narrative. This was to ensure historically plausible correlations between different risk factors within product groups, as far as possible. As such, the design of the Baseline Market Stress Scenario utilises and incorporates the most severe historical market stress scenarios, but without replicating any individual historically observed scenarios or shocks.

The severity of the market shock scenarios in the Baseline Market Stress Scenario are then calibrated such that in combination, and with reference to the volumes of products cleared at each UK CCP Clearing Service, the Baseline Market Stress Scenario is broadly equivalent in severity to the worst historical stress experienced for each UK CCP Clearing Service.footnote [12] As such, this is an extreme scenario, and at the limits of historical observations as at the launch of the 2021–22 CCP exercise in October 2021.

This scenario does not cover all possible sizes and combinations of market price shocks to which CCPs could be exposed. For example, the Baseline Market Stress Scenario is not concentrated in certain asset classes, and does not centre on large hypothetical shocks intended to go beyond historical limits in selected asset classes or products.

Since the launch of the 2021–22 CCP SST exercise, there have been large price shocks in some markets which in some cases have gone beyond those previously historically observed. Due to the timing of the 2021–22 CCP SST, these realised market stresses are not incorporated into the historical observations used to inform calibration of the Baseline Market Stress Scenario – though they will feature in future tests.

Further, while the Baseline Market Stress Scenario is calibrated to be broadly equivalent in overall severity to the worst historical stress for each UK CCP Clearing Service, the Bank judges that the worst two-day shocks over March 2022 were more severe overall for one UK CCP Clearing Service (LME Base) than the Baseline Market Stress Scenario.

For the purposes of sensitivity testing and reverse stress-testing analysis, the 2021–22 CCP SST also includes three additional market stress scenarios. Each of these are linear multipliers of the Baseline Market Stress Scenario. The first is a 0.8x multiplier of the Baseline Market Stress Scenario, in which each of the individual risk factor shocks specified in Annex A is multiplied by 0.8. Overall, this scenario is broadly equivalent in severity to 99.95% of the historical worst market stress for each individual Clearing Service.

The second and third additional market stress scenarios are 1.2x and 1.6x multipliers of the Baseline Market Stress Scenario, respectively. These scenarios are (overall) more severe than those historically observed, including the stress scenarios observed in March 2022 for UK CCPs clearing commodity products. These additional market stress scenarios also contain individual market shocks greater than historically observed for a variety of, but not all, individual risk factors.

Each of the Baseline Market Stress Scenario and additional market stress scenarios are applied to each CCP on a common reference date of end of day 17 September 2021. This reference date determines the market prices to which the market price shocks are applied, as well as CCP exposures and resources. The 17 September 2021 reference date was selected to capture settlement dates and expiries for particular contracts within our five-day stress period. CCP resources, CCP exposures and market prices on this date were generally representative of those over the previous 12 months. Clearing Member defaults also apply as at end of day 17 September. At this point, it is assumed that no payments are exchanged between CCPs and defaulting Clearing Members, no position changes are accepted, and hence no further payments or margin contributions are made to CCPs.

In order to ensure a complete and accurate reflection of the impact of the Baseline Market Stress Scenario on positions at UK CCPs, each CCP was required to extrapolate the 119 individual risk factor shocks prescribed by the Bank to all products and exposures within their respective clearing businesses. This extrapolation was undertaken in a manner consistent with the overall ‘risk-off’ narrative and intended severity of the Baseline Market Stress Scenario. The Bank reviewed each of the CCPs approach to extrapolation.

5: Credit Stress Test

Purpose and objectives

The Credit Stress Test component tests CCPs’ resilience against the combination of the Baseline Market Stress Scenario detailed in Section 4 plus the simultaneous default of a given Clearing Member population. The Credit Stress Test component comprises three sub-components:

  • Standard Credit Stress Test: The Standard Credit Stress Test assesses the sufficiency of CCPs’ resources to absorb losses under combination of the market price shocks specified in the Baseline Market Stress Scenario, plus the simultaneous default of the Cover-2 population for each CCP Clearing Service. No concentration costs are included.
  • Credit & Concentration Stress Test: The Credit & Concentration Stress Test assesses the sufficiency of CCPs’ resources to absorb losses under the combination of the market price shocks specified in the Baseline Market Stress Scenario, plus the simultaneous default of the Cover-2 population for each CCP Clearing Service, plus severe but plausible estimates of concentration costs. Concentration costs are the additional costs that CCPs face when they liquidate (through auction or hedging) concentrated positions of defaulters.
  • Cover-X analysis: Cover-X analysis is used to assess the sufficiency of CCPs’ resources to absorb losses under the combination of market price shocks specified in the Baseline Market Stress Scenario, plus the simultaneous default of a customised selection of Clearing Member groups. The purpose of this analysis is to examine the sufficiency of resources sized in the context of the Cover-2 standard to the default of any other number, profile and combination of Clearing Members. In the 2021–22 CCP SST, Cover-X analysis specifically explores the default of two customised groups of Clearing Members. First, the default of non-bank Clearing Members, on the basis that these entities are typically subject to less regulatory scrutiny than larger Clearing Members. Second, the default of Clearing Members with lower credit ratings, on the basis that these entities have a greater implied probability of default. In both cases, the analysis includes severe but plausible estimates of concentration costs.

Each of these sub-components include sensitivity testing to examine the impact of alternative assumptions regarding CCPs’ ability to successfully port the client accounts of defaulting Clearing Members to non-defaulting Clearing Members.

Methodology

Overview

The Credit Stress Test aims to reflect, as closely as possible, the actual processes and mechanics of the default of a given population of Clearing Members in a market stress scenario, based on the applicable regulations and CCPs’ rulebooks. Where modelling assumptions are required, for example in the estimation of concentration costs, the Bank has developed and applied its own bespoke and conservative models.

The calculations in the Credit Stress Test, detailed below, have been performed by the Bank, but utilise data inputs requested from the CCPs. In particular, CCPs provided data on the impact of the relevant market stress scenarios on Clearing Member and Client positions at the account level (ie profits and losses resulting from the market shocks in those market stress scenarios). It was necessary to rely on CCPs’ established infrastructure to perform the full and exact revaluation of positions given the complexity of some of the products cleared by UK CCPs. However, the Bank has reconciled, sense-checked and validated the data submitted by CCPs, using other information sources available to the Bank where appropriate.

Calculation process

The Credit Stress Test is performed by assessing the impact on individual CCP Clearing Services’ financial resources under the Baseline Market Stress Scenario and simultaneous default of a given Clearing Member population.

The Credit Stress Test calculation is performed from the account level up. This allows various client porting assumptions, and the appropriate allocation of concentration costs. Where porting of client accounts is assumed (see ‘Porting assumptions’), client accounts are assumed to be moved across to a new Clearing Member with all their positions and account-level resources and are thus excluded from the rest of the calculation process.

For all non-ported client accounts, the surplus or deficit of resources at account level is determined based on the profit-and-loss (PNL) impact of the Baseline Market Stress Scenario, estimated concentration costs where applicable (see Box A for further information), and applicable account level prefunded resources.footnote [13] Account segregation rules are then used to determine the overall impact at the Clearing Member level. In general, house accounts are always aggregated. Non-ported client accounts are aggregated only in the event of a deficit, as any surplus would be due to the client in question and the CCP would not be able to use it to service losses on other accounts.footnote [14]

The final step is to calculate the applicable surplus/deficit for the defaulting Clearing Members groups based on the net surplus/deficit on consolidated accounts.footnote [15] Under CCPs’ rules, defaulting Clearing Members are resolved separately, even if they are part of the same corporate group. Therefore, in calculating the final impact on mutualised resources, Clearing Members with a surplus are not included (as the surplus would be due to them and cannot be used to offset losses of other Clearing Members in the defaulting group). For Clearing Members with a deficit over their margin resources, quantification of the impact of such losses is undertaken as follows: first against their own Default Fund contributions, then against further resources available to the Clearing Services under their respective Default Waterfalls (in the following order of application):

  • Skin in the Game (SITG): CCPs’ own capital set aside to absorb defaulters’ losses in the first instance.
  • The mutualised Default Fund: Contributions of non-defaulting Clearing Members that can be used to absorb default event losses beyond SITG and would require replenishing by non-defaulting Clearing Members.
  • Powers of Assessment: Additional non-prefunded resources that can be called by the CCP from non-defaulting Clearing Members in a given Clearing Service to cover default event losses, where a default event causes losses exceeding the mutualised Default Fund.footnote [16]

This calculation is performed in full for every combination of defaulting Clearing Members within the scope of the 2021–22 CCP SST exercise.

Defaulter selection

The Credit Stress Test component includes a number of alternative approaches to selecting the defaulting Clearing Member population in the Baseline Market Stress Scenario.

The focus of the Standard Credit Stress Test and the Credit & Concentration Stress Test is the default of the Cover-2 population at each CCP Clearing Service. This is defined as the two Clearing Member groups whose default generates the greatest depletion of resourcesfootnote [17] at the CCP Clearing Service level, under the relevant market stress scenario. The focus on the Cover-2 population at the Clearing Service level reflects UK CCPs having multiple, segregated Default Funds for different asset classes,footnote [18] between which the Cover-2 population will differ. All Clearing Members within the defaulting Clearing Member group are assumed to default at the relevant CCP Clearing Service. However, a Clearing Member defaulting at one CCP Clearing Service does not necessarily default at any other CCP Clearing Services unless also included in the Cover-2 population at those Clearing Services.

While not a focus of the analysis, results of the Standard Credit Stress Test and Credit & Concentration Stress test are also presented (in Annex B) under the default of the system-wide Cover-2 population. This is defined as the two Clearing Member groups whose default leads to the greatest absolute stressed losses over defaulting member resources across all CCP Clearing Services in aggregate.

The Cover-2 population under both approaches is determined dynamically. That is, the Cover-2 population is algorithmically determined for each CCP Clearing Service, or system-wide, for any combination of market stress scenario and all other input assumptions (such as the inclusion of concentration costs, or relevant porting assumption). By incorporating estimated concentration costs, the dynamic Cover-2 selection methodology calculates the depletion of CCP Clearing Service resources under every pair of Clearing Member groups to identify the pair whose default generates the greatest depletion when the estimated concentration costs related to the combined positions of the defaulters are included. Further detail on the concentration cost methodology is provided in Box A below.

In contrast to the Cover-2 methodology, the Cover-X analysis enables the selection of a customised population of defaulting Clearing Members. This could include any number, profile or combination of Clearing Members. In the 2021–22 CCP SST exercise, Cover-X analysis is used to explore the default of two specific groups of Clearing Members. First, the default of all non-bank Clearing Members, as identified by the Bank, at each CCP Clearing Service. Second, the default of all Clearing Members with lower credit ratingsfootnote [19] at all CCP Clearing Services.

Porting assumptions

Each of the Credit Stress Test sub-components assess the impact on CCPs under different assumptions regarding CCPs’ ability to port the client accounts of defaulting Clearing Members to non-defaulting Clearing Members. Three different assumptions are explored in order to provide insights on the quantitative impact of porting on CCPs’ resilience:

  1. No porting: No client accounts port from defaulting Clearing Members to non-defaulting Clearing Members. This is generally the most conservative porting assumption in the Credit Stress Test component.
  2. Segregated client accounts port: Client accounts that are individually segregated (ISEG) and legally segregated operationally comingled (LSOC) are assumed to successfully port from defaulting Clearing Members to non-defaulting Clearing Members. Omnibus accounts do not port from defaulting Clearing Members to non-defaulting Clearing Members.
  3. All client accounts port: All client accounts are assumed to successfully port from defaulting Clearing Members to non-defaulting Clearing Members, including both segregated and omnibus accounts.

Box A: Concentration cost methodology

Purpose and scope of the inclusion of concentration costs

Concentration costs are the costs over and above the impact of the prescribed market stress scenario that CCPs would face when liquidating (through auction or hedging) concentrated positions of defaulters.

The inclusion of concentration costs in the 2021–22 CCP SST exercise aims to provide a conservative view of the impact of the combined market stress scenario and default of Clearing Members on CCPs. CCPs are required to fully auction the positions of defaulting Clearing Members in a short period of time (potentially hedging or selling off some of the positions in the market before the auction process). Where these positions are material, it is likely that the CCP will need to take a discount on the market value of these positions in order to liquidate them.

The calculation of concentration costs necessarily requires estimation. Unlike the impact of the prescribed market stress scenario, which for a given portfolio can be calculated with precision, potential incremental concentration costs are conditional and as such cannot be quantified with certainty.

The Bank’s methodology for estimating concentration costs incorporates conservative assumptions and calibration choices. It therefore provides a severe but plausible estimate of concentration costs rather than a judgement of the expected or most likely concentration costs. As such, the analysis in the 2021–22 CCP SST is focused on the high-level impact of the inclusion of concentration costs on the resilience of CCP Clearing Services, rather than a granular analysis of resources collected by CCPs specifically to cover concentration costs (which are subject to regulatory scrutiny via alternative routes).

Calculation of concentration costs

The Bank uses an in-house methodology, rather than replicating the concentration add-on calibration performed by CCPs. In particular, the Bank’s methodology follows the logic that the incremental costs demanded by the market on concentrated positions can be implied from the additional market risk these positions would be exposed to if liquidated gradually over a period of time such that liquidation itself would not lead to a material change in price.

To calculate concentration costs, positions on all non-ported accounts within the given defaulting Clearing Member population are first aggregated (netted) at a granular product level. This ensures the analysis is based on the actual aggregated positions in every product that a CCP would have to liquidate in the event of the default of a given Clearing Member population. For selected specifically related products, the calculation methodology recognises a conservatively modelled reduction of concentration costs on opposite direct positions. Typically, this relates to calendar spreads or basis exposures in related products, where there are high levels of historically observed correlation even during periods of stress.

For each granular product, the Bank then calculates severe but plausible potential market risk losses that the exposure could generate if liquidated gradually in order to avoid a concentration premium. This calculation is based on a conservative assumption that CCPs can only liquidate exposures equivalent to 25% of the daily average volumes tradedfootnote [20] in a given product each day before facing a concentration premium. Calculation of costs at a granular product level is a very conservative approach as, in practice, auction portfolios would benefit from diversification of risk and could attract lower concentration premiums in general. For the purposes of this calculation, it is assumed that market participants have no interest in taking on the positions in question for any reason, other than the attractive premium that they could demand. This is a simplifying assumption; in reality some counterparties could, for example, have opposite exposures they would like to hedge in a stress.

Once calculated, concentration costs estimates for each granular product are allocated back to the accounts of defaulting Clearing Members proportionally to the volume of positions held in those accounts. This allows the Bank to perform the calculation of the impact of the inclusion of concentration costs within the applicable account segregation rules detailed above.

Results

Standard Credit Stress Test

Chart 1 shows the results of the Standard Credit Stress Test, in which concentration costs are excluded. For each CCP Clearing Service, Chart 1 shows the total size of stressed losses over defaulting members’ resources under the CCP Clearing Service level Cover-2 population, and the proportion of SITG, mutualised Default Fund contributions, and Powers of Assessment depleted (as appropriate).

As shown in Chart 1, stressed losses over defaulting members’ resources vary across CCP Clearing Services, but there is only low to moderate (if any) depletion of mutualised Default Fund contributions under the Baseline Market Stress Scenario and default of the Cover-2 population at each CCP Clearing Service. Under the assumption that there is no porting of client accounts from defaulting Clearing Members to non-defaulting Clearing Members, aggregate stressed losses over defaulting members’ resources are approximately £1.9 billion, and are greatest, in absolute amounts, at LCH SwapClear reflecting the large size of this Clearing Service. Depletion of mutualised Default Fund resources is proportionally largest at LME Base at 35%. Three CCP Clearing Services observe no stressed losses over defaulting member resources (SLOMR).

The findings that there is only low to moderate depletion of mutualised Default Fund contributions remains true under all three porting assumptions. However, Chart 1 illustrates that the resilience of most CCP Clearing Services is sensitive to assumptions regarding CCPs’ ability or inability to successfully port client accounts at defaulting Clearing Members to non-defaulting Clearing Members. As would be expected, these benefits are observed most clearly where client clearing represents a greater share of clearing activity. In the case of LCH SwapClear, these benefits are observed when segregated client accounts are assumed to successfully port. For ICEU F&O and LME Base, these benefits predominantly arise when all client accounts (including gross and net omnibus accounts) are assumed to successfully port.

Chart 1: Standard Credit Stress Test results (a) (b) (c) (d)

Baseline Market Stress Scenario, Clearing Service Cover-2, all porting assumptions (e)

LCH SwapClear, LCH RepoClear, ICEU F&O and LME Base experience low to moderate depletion of the Default Fund in the credit only stress test.

Footnotes

  • (a) Stressed Losses over defaulting Members’ Resources (SLOMR) is the absolute amount (£ millions) by which losses exceed defaulters’ resources (Initial Margin and Default Fund contributions).
  • (b) Percentage usage of dedicated CCP resources (SITG).
  • (c) Percentage usage of mutualised Default Fund (DF), consisting of non-defaulters’ Default Fund contributions.
  • (d) Percentage usage of Power of Assessment (PoA). PoA represents the total amount of non-prefunded resources that CCPs can call from non-defaulters.
  • (e) A = ‘No porting’ (no client accounts at defaulting Clearing Members port to non-defaulting Clearing Members), B = ‘Segregated accounts port’ (only the segregated client accounts port), and C = ‘All accounts port’ (all client accounts port, including omnibus accounts).

Results of the Standard Credit Stress Test under the default of the system-wide Cover-2 population are presented in Annex B. The impact of the default of the system-wide Cover-2 population cannot by definition drive losses greater than those under the default of the CCP Clearing Service level Cover-2 (Chart 1).

Credit & Concentration Stress Test

Chart 2 shows the results of the Credit & Concentration Stress Test, in which the Bank’s estimates of concentration costs are additionally included.

Chart 2 illustrates that including estimated concentration costs can have a material impact on the level of Default Fund consumption at CCP Clearing Services. Under the most restrictive ‘no porting’ assumption, for example, allowing for concentration costs in the selection of the Cover-2 population can increase stressed losses over defaulting members’ resources by around 200% for some Clearing Services. With respect to the depletion of prefunded resources, the most material impact resulting from the inclusion of estimated concentration costs is at LME Base. In most part, this is due to the Cover-2 Clearing Member population having particularly large exposures in some products relative to the daily average volume traded for those products. For another Clearing Service (LCH ForexClear) inclusion of concentration cost results in roughly one-third of the mutualised Default Fund being depleted, in contrast to having no stressed losses over defaulting members’ resources in the Standard Credit Stress Test. For this Clearing Service these concentration costs arise on the relatively large positions of the defaulting Clearing Members in less liquid currency markets.

Chart 2 also illustrated that, while no CCP Clearing Service experiences a full depletion of prefunded financial resources when estimated concentration costs, results vary between CCP Clearing Services. For some Clearing Services, defaulting Clearing Members’ own resources are sufficient to meet losses, while other CCP Clearing Services observe only low to moderate depletion of prefunded resources. For LME Base losses result in close to full depletion of prefunded resources when estimated concentration costs are included under the ‘no porting’ assumption.

As in the Standard Credit Stress Test, the ability to successfully port client accounts at defaulting Clearing Members to non-defaulting Clearing has benefits at CCP Clearing Services where client clearing represents a greater share of clearing activity.

Chart 2: Credit & Concentration Stress Test results (a) (b) (c) (d)

Baseline Market Stress Scenario, Clearing Service Cover-2, all porting assumptions (e)

LME Base experience almost full depletion of the Default Fund. Most other services experience low to moderate depletion of the Default Fund.

Footnotes

  • (a) Stressed Losses over defaulting Members’ Resources (SLOMR) is the absolute amount (£ millions) by which losses exceed defaulters’ resources (Initial Margin and Default Fund contributions).
  • (b) Percentage usage of dedicated CCP resources (SITG).
  • (c) Percentage usage of mutualised Default Fund (DF), consisting of non-defaulters’ Default Fund contributions.
  • (d) Percentage usage of Power of Assessment (PoA). PoA represents the total amount of non-prefunded resources that CCPs can call from non-defaulters.
  • (e) A = ‘No porting’ (no client accounts at defaulting Clearing Members port to non-defaulting Clearing Members), B = ‘Segregated accounts port’ (only the segregated client accounts port), and C = ‘All accounts port’ (all client accounts port, including omnibus accounts).

Results of the Credit & Concentration Stress Test under the default of the system-wide Cover-2 population are presented in Annex B. As for the Standard Credit Stress Test, stressed losses are smaller than those under the default of the CCP Clearing Service level Cover-2. Notably, absolute stressed losses over defaulting members’ resources are concentrated in LCH SwapClear. This is unsurprising given LCH SwapClear is the largest UK CCP Clearing Service.

Cover-X analysis

Chart 3 illustrates the findings of the Credit Stress Test under the default of the non-bank Cover-X population, when including concentration costs. Under this approach, all non-bank Clearing Member entities are assumed to default at each CCP Clearing Service.

These results are more benign than under the default of the CCP Clearing Service level Cover-2 population in the Credit & Concentration Stress Test. However, three CCP Clearing Services still experience stressed losses over defaulting members’ resources, and two (ICEU F&O and LME Base) experience low levels of depletion of the mutualised Default Fund. Both of these CCP Clearing Services have a relatively higher number of non-bank Clearing Members compared to other CCP Clearing Services.

Chart 3: Credit & Concentration Stress Test results (a) (b) (c) (d)

Baseline Market Stress Scenario, non-bank Cover-all, all porting assumptions (e)

ICEU F&O and LME Base experience low depletion of the Default Fund. LCH RepoClear experiences moderate depletion of Skin in the Game.

Footnotes

  • (a) Stressed Losses over defaulting Members’ Resources (SLOMR) is the absolute amount (£ millions) by which losses exceed defaulters’ resources (Initial Margin and Default Fund contributions).
  • (b) Percentage usage of dedicated CCP resources (SITG).
  • (c) Percentage usage of mutualised Default Fund (DF), consisting of non-defaulters’ Default Fund contributions.
  • (d) Percentage usage of Power of Assessment (PoA). PoA represents the total amount of non-prefunded resources that CCPs can call from non-defaulters.
  • (e) A = ‘No porting’ (no client accounts at defaulting Clearing Members port to non-defaulting Clearing Members), B = ‘Segregated accounts port’ (only the segregated client accounts port), and C = ‘All accounts port’ (all client accounts port, including omnibus accounts).

Chart 4 shows the results of the Credit & Concentration Stress Test under the default of all Clearing Member groups with a credit rating of BBB and below, when including concentration costs. This approach is used to examine the impacts when a larger number of smaller Clearing Members, who each have a greater implied probability of default, each default simultaneously. As illustrated, the default of this Clearing Member population does not result in material utilisation of the mutualised Default Fund at any Clearing Service.

Chart 4: Credit & Concentration Stress Test (a) (b) (c) (d)

Baseline Market Stress Scenario, credit rating Cover-X, all porting assumptions (e)

LCH SwapClear, ICEU F&O and LME Base experience low depletion of the Default Fund. LCH ForexClear experiences partial depletion of Skin in the Game.

Footnotes

  • (a) Stressed Losses over defaulting Members’ Resources (SLOMR) is the absolute amount (£ millions) by which losses exceed defaulters’ resources (Initial Margin and Default Fund contributions).
  • (b) Percentage usage of dedicated CCP resources (SITG).
  • (c) Percentage usage of mutualised Default Fund (DF), consisting of non-defaulters’ Default Fund contributions.
  • (d) Percentage usage of Power of Assessment (PoA). PoA represents the total amount of non-prefunded resources that CCPs can call from non-defaulters.
  • (e) A = ‘No porting’ (no client accounts at defaulting Clearing Members port to non-defaulting Clearing Members), B = ‘Segregated accounts port’ (only the segregated client accounts port), and C = ‘All accounts port’ (all client accounts port, including omnibus accounts).

Further, a separate analysis suggests that when considerin