The Commodity Futures Trading Commission’s (CFTC) Division of Clearing and Risk (DCR) and the Office of the Chief Economist (OCE) has issued CCP Supervisory Stress Tests: Reverse Stress Test and Liquidation Stress Test, a two-part report that includes the results of a reverse stress test of central counterparties (CCPs) or clearinghouses resources and an analysis of stressed liquidation costs. This is the third in a series of supervisory stress testing exercises and resulting reports on CCPs that CFTC staff has conducted. Previous stress testing reports were issued in 2016 and 2017.
Reverse Stress Test
The reverse stress test analysis included futures and options at CME Clearing and interest rate swaps at LCH Ltd. Both house accounts and customer accounts of all clearing members (CMs) were analyzed, using actual positions as of September 5, 2018.
The purpose of the exercise was to identify combinations of market shocks and CM defaults which would consume pre-funded resources, which include defaulting CMs’ initial margin, CCP-committed capital, and guaranty fund. Market shocks were based on four extreme historical dates, as well as scenarios that represent two and five times the moves on these dates.
The results of the reverse stress test indicate that the two tested CCPs would have sufficient pre-funded resources to cover losses even if all CMs with losses defaulted under certain extreme historic one-day scenarios.
One scenario includes market shocks five times the size of those experienced on the day following the Lehman Brothers bankruptcy announcement; this scenario included, for example, price moves as large as 225 bps in swap rates, and 25 percent in stock index futures. These moves likely exceed possible market risk at the CCPs, and thus may be considered implausible. Under this market scenario, only two firms experienced stress losses greater than initial margin at both CCPs concurrently. If both firms defaulted, the combined shortfall would have been slightly greater than pre-funded resources at both CCPs. As the analysis did not include assessment powers, the CCPs would have access to additional resources not considered in the exercise.
The analysis of liquidation margin add-ons included interest rate swaps at both CME Clearing and LCH Ltd. Only the 10 house accounts with the largest liquidation margin add-ons as of June 30, 2018 were included.
The purpose of the exercise was to test whether there would have been sufficient pre-funded resources available if the actual costs of hedging and auctioning the portfolio of a defaulting member exceeded CCP estimates. The analysis was not a test of liquidation margin adequacy.
Results suggest pre-funded resources would have been sufficient to cover extreme but plausible market losses plus liquidation expenses for two house accounts even if the actual liquidation costs were double the amount of the liquidation margin add-on. This analysis, like the reverse stress exercise, did not include assessment powers.