WFE issues guidance on CCP non-default losses

Nandini Sukumar, Chief Executive Officer, WFE

Although non-default losses (NDLs) are rare events at central counterparties (CCPs), there needs to be a framework in place to mitigate any risks and reduce ambiguity just in case there is an occurrence, according to guidelines published by the World Federation of Exchanges.

As Nandini Sukumar, Chief Executive Officer of the WFE, put it, “Non-default losses may not be the main risk faced by CCPs, but it is still important to have a structured approach to dealing with them. That way, CCPs can devote more time to their day job, ensuring that uncertainty over counterparty credit exposures does not threaten the integrity of the financial system. This is why the WFE has taken the initiative to highlight the responsible, constructive practices employed by clearing houses in relation to potential incidents and their financial consequences if any.”

NDLs are losses incurred from operational, custody and investment risks, and are unrelated to a clearing member default, which is managed through the provisions of the ‘default waterfall. The WFE says that they would not necessarily lead to a loss, given the operational resilience of CCPs and their risk mitigation practices. For example, none of the top 10 CCPs has in practice ever allocated NDLs to users.

The paper notes that while the exact policy for NDLs is a matter for each individual CCP, operational resilience of their market infrastructures as well as robust enterprise risk management practices should continue to remain important planks of a CCP’s framework for mitigating the risk of NDLs occurring in the first place.

Ongoing focus should also be on information technology and cyber security, where vulnerability assessments, enhanced software testing, comprehensive monitoring, and benchmarking and board-reporting are best practices.

NDLs have continued to be a hot topic of debate and discussion in the industry. The challenges were highlighted in a speech by Fabio Panetta, Member of the Executive Board of the ECB, at the Second Joint Bundesbank/ECB/Federal Reserve Bank of Chicago Conference on CCP Risk Management in February.

Panetta called for more action to be taken to conceptualise NDL scenarios, reliable tools for absorbing the associated losses, and the roles and responsibilities of the various stakeholders. “There are far fewer prefunded resources available for non-default losses than for default losses, so the risk of entering into CCP recovery or resolution for non-default related reasons may be higher than for default-related reasons. It is therefore critical to make progress in this area,” he said.

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