Swap clearinghouses in a default situation could pose a huge threat to the markets and thus need more oversight. That’s according to Mark Wetjen, commissioner at the Commodity Futures Trading Commission. Speaking to a conference in Singapore, Mr. Wetjen, citing a Korean securities firm that ran into trouble, said the clearing sector needs a better loss absorption structure as well as more transparency.
In December 2013, a small, Korean securities firm suffered big losses due to a trading error. The firm subsequently defaulted, creating a loss at the affiliated clearinghouse. The clearinghouse, or central clearing party (CCP), was able to sustain the loss by using parts of guaranty fund, but this had the knock-on effect of other clearing members losing some portion of their default-fund contributions.
“One could say that the fundamental framework for loss-mutualization was tested and proved sufficiently resilient at the Korea clearinghouse given the fact that losses of the defaulting securities firm were absorbed, and trading on the exchange resumed relatively quickly,” Mr. Wetjen said in his remarks. “Nonetheless, we should always ask whether the regulatory framework can be improved.”
In improving the framework regulators should consider requiring the CCP to put up its own funds as collateral vs. depending on a guaranty fund, Mr. Wetjen said. Currently the CFTC doesn’t require CCPs putting skin in the game.
Many of the larger clearinghouses already do put their own money up against potential losses at counterparties. Mr. Wetjen cites several, including the CME, which has a corporate contribution equal to $100,000,000 in its Base (futures) Guaranty Fund, and ICE Clear Credit, which has a “priority contribution” to the General Guaranty Fund of $25,000,000 in addition to a “pro rata contribution” of $25,000,000 to the same fund.
Mr. Wetjen wants rules that address an appropriate CCP capital contribution size, for instance, “a fixed percentage of the guaranty fund, or equal to the largest single clearing member contribution.” He also agrees with those who think CCP’s capital contribution to the guaranty fund “should always be used before the contributions of non-defaulting clearing members.”
Other areas where CCPs could improve include making CCPs transparent, particularly with regard to standardizing stress tests, Mr. Wetjen said. Also, he said, making sure that “recovery and wind down plans are effective and realistic, including whether to prohibit CCPs from allocating losses to customers in their recovery plans.”