Over the past few weeks, the U.S. Office of Financial Research (OFR) has published a trio of papers looking at various aspects of central counterparties (CCPs). These papers range from the best way to stress test CCPs, to the adequacy of CCP margin requirements and the relative risks and utility of central clearing to repo markets.
On February 21, 2017, the OFR published a working paper entitled, "Persistence and Procyclicality in Margin Requirements." This paper was authored by Professor Paul Glasserman and Qi Wu of the Chinese University of Hong Kong on behalf of the OFR. The paper analyzes the consequences of imposing “risk-sensitive” margin requirements. The paper concludes that doing so could result in increased margin requirements at times when market participants may find it the most difficult to raise the necessary assets to post as collateral. The paper also describes how margin levels for derivatives contracts could be set so that margin calls do not add to market stress during times of instability.
The next day on February 22, 2017, the OFR issued a research brief, entitled, “Measuring Systemwide Resilience of Central Counterparties.” The brief authored by Stathis Tompaidis of the OFR and the University of Texas at Austin posits a new way to conduct a U.S. systemwide stress test of CCPs. The novel approach proposed by Professor Tompaidis takes into account the effect of losses and defaults at CCPs’ member banks to create a combined supervisory stress test across CCPs and their clearing members. Among the advantages offered by Professor Tompaidis’s approach are that it would require only a small amount of additional effort by companies because regulators can use the results of existing stress tests of CCPs.
On March 9, 2017, the OFR published a third paper, "Benefits and Risks of Central Clearing in the Repo Market.” This research brief written by Viktoria Baklanova and Ocean Dalton of the OFR, and Stathis Tompaidis of the OFR and University of Texas at Austin uses data from the OFR’s interagency bilateral repo data collection pilot study to examine the relative risk-reduction from central clearing of repos against the potential risks that CCPs themselves face from resulting larger exposures. As regulations drive repo between dealers and non-dealers toward central clearing, the OFR’s analysis attempts to quantify to what extent one set of risks is being traded for another:
"This brief estimates that extending U.S. Treasuries repo CCP services to nondealer counterparties would result in a reduction of up to 81 percent of risk exposures for dealers. This decline exceeds the 63 percent reduction from bilateral netting alone. This potential reduction of exposures provides an economic incentive for repo market participants to use a repo CCP for dealer-to-nondealer transactions. At the same time, expanding access to a repo CCP for nondealers increases the risk exposure for the CCP by as much as 75 percent. Whether the potential benefits outweigh the costs depends on the cost of bilateral repo activity relative to the cost of raising additional funds to guarantee centrally cleared transactions."