The World Federation Of Exchanges guides clearing houses on non-default losses
Industry group the World Federation of Exchanges has issued guidance to central counterparty clearinghouses (CCPs) over how to allocate non-credit losses.
CCPs serve derivatives and securities markets by reducing counterparty credit risk in case those involved in a transaction default on a contractual obligation.
In addition to those main risks, the WFE urges CCPs to consider their response to various non-credit losses that might occur, such as in the case of a cyber-theft or a banking failure. The body says it is important that these losses are allocated in a “transparent, predictable and equitable manner”.
CCPs require market participants to back the risks they take, and CCPs back their own business offering with capital, that will typically be used to absorb losses. WFE says that process remains subject to CCP users sharing liability appropriately, in a manner set out by the clearing house’s rule book.
The WFE notes that the exact policy is a matter for each individual CCP, with the new paper setting out some key instances and considerations.
Nandini Sukumar, chief executive officer of the WFE, says: “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.”
In practice, non-default losses are rare, and no top-ten CCP has ever allocated non-default losses to users.