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AMEDA Leadership Forum Alexandria, Egypt, 27-29th April

CCPs and other Risk Containment Models. AMEDA Leadership Forum Alexandria, Egypt, 27-29th April. Agenda. What is Counterparty Risk? What is a Central Counterparty (CCP)? Advantages and Disadvantages of a CCP? CCP Risk Models and Alternatives. What is Counterparty Risk?.

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AMEDA Leadership Forum Alexandria, Egypt, 27-29th April

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  1. CCPs and other Risk Containment Models AMEDA Leadership Forum Alexandria, Egypt, 27-29th April

  2. Agenda • What is Counterparty Risk? • What is a Central Counterparty (CCP)? • Advantages and Disadvantages of a CCP? • CCP Risk Models and Alternatives

  3. What is Counterparty Risk? • ‘The risk that a counterparty will not settle its obligations for full value at any time’ i.e. will default on a contract. • Two components to potential losses: • Principal (or Direct) Loss: loss of securities or cash value where one part has delivered (with finality) and the other does not. • Consequential Loss: indirect losses caused by inability to settle transactions due to default of a counterparty (e.g. loss of liquidity, missed corporate action, loss of profit for onward sell, costs incurred to cover a short generated by the fail, penalties due to short position generated etc). • Importance of controlling counterparty risk exposures has risen significantly post-Lehmans.

  4. What is a Central Counterparty (CCP)? A CCP is “an entity that interposes itself between counterparties to contracts in one or more financial markets, becoming the seller to the buyer and the buyer to the seller” CPSS/ IOSCO Recommendations for Central Counterparties November 2004 • CCP defined by legal/contractual obligations for transactions it clears, NOT by function. Central Novation or Open Offer are main legal mechanisms. • A CCP ultimately takes Counterparty Risk on itself, as opposed to mutualising the risk exposure amongst its members.

  5. Advantages and Disadvantages of a CCP • Advantages - • Don’t have to worry about the credit risk of your counterparty • Quasi-utility status of CCP may mitigate political risks of intervention • Risk is centralised and transparent so can be managed more efficiently • Provides legal foundation for certainty of settlement guarantee • Provides for settlement anonymity • Needed for order-driven markets where brokers are weak • Disadvantages – • Enormous concentration of risk means CCPs become systemically critical • Risk model only as good as the algorithms and quality of collateral • Another layer of cost • Netting diminishes CSD settlement revenues • Exposures to CCP – credit risk, operational risks • Requires ‘water-tight’ legal framework for netting, margins/collateral and finality. • Only covers T+3 settlement

  6. CCP Risk Models and Alternatives • Example Risk Model: LCH Clearnet (UK and Euronext). • Strict membership criteria ensures high quality counterparties • Real-time novation/ Open Offer of cash market trades • Clearing members become the ‘Principal’ to trades • Multilateral netting to reduce value at risk • Initial and variation margins marked to market • Intraday margin calls • Clearing fund to cover risk in abnormal market positions • Buy-in/Sell-out (BiSo) capabilities • Secure Payments system • Was using insurance policy against default (until December 2008) • NB. Risk model only covers the Clearing Members, NOT their clients. Clients have exposure to their Clearing Member.

  7. CCP Risk Models and Alternatives

  8. CCP Risk Models and Alternatives CCP – USA, Euronext, Germany, UK, Italy, Japan CCP Lite – Poland, Hungary, Austria, Canada Clearing House – Russia, Korea, Pakistan, Turkey Settlement Guarantor – Greece, Cyprus, Spain, Egypt, South Africa

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