Market participants post collateral at CCPs to guarantee their counterparties’ compensation if they would default. Requiring a little extra in good times will, smartly, mean there is less of a shocking hike when bad times hit, and less risk of an evil “pro-cyclicality” spiral in the markets. But is it legitimate that CCPs hold member money when it’s not actually needed? And what is pro-cyclicality, actually, anyway? A panel on the first day of the WFEClear conference in Seoul dug in.
Our coverage of WFEClear 2025 is gathered here.
The more the market swings, the bigger the shock buffers must be to guarantee that a trade participant gets paid if its counterparty goes into distress. This correlation between volatility and collateral requirements, at the central counterparty clearinghouses (CCPs), means there is no escape from the fact that margin calls from the clearinghouses will fundamentally be “pro-cyclical”. In other words, when markets shake (and it often gets harder to get hold of money), the money that CCPs suck up will make matters even worse in the market, setting off the dangerous spiral.
On Tuesday afternoon in Seoul, two sessions in a row put a lot of focus on the dilemmas and operational challenges for clearinghouses in managing that risk of contributing negatively to bad markets.
The first was a panel covering the cyclicality only as one of many current topics. Discussions touched also on questions such as CCPs’ access to settlement in central bank money, resolution-related rules such as for “porting” of assets if a CCP would have to be wound down, etc. On one hot topic in the clearing world – the transparency and clarity of CCPs in explaining their risk models so market participants can predict increased margin calls in situations of market turbulence – it was noted that this had improved through new rules recently. That area has built-in dilemmas, as a good model is not necessarily simple to explain, and the sophistication of the models is developing over time.
On stage with this session were …
Laura Bayley, Head of Clearing Services with the SIX Group,
Sebastijan Hrovatin, Deputy Head of the Financial Markets Infrastructure unit at the European Commission, and
Boon Gin Tan, CEO of Singapore Exchange Regulation, SGX,
under moderation by Richard Metcalfe, Head of Regulatory Affairs at the World Federation of Exchanges (WFE).
Since the financial crisis that culminated in 2008, global regulation of CCPs has been coordinated not least by CPMI-IOSCO, a forum for the world’s regulatory authorities. On cyclicality, as with many other aspects, a central policy choice is whether mandates are needed or whether improvement can be self-driven by the market’s stakeholders on commercial basis. SIX’s Laura Bayley suggested the latter.
It is a common view that CCPs should hold relatively high margin amounts in normal times so that the shock in bad times gets smaller. However, this raises the question of what’s the legitimacy in CCPs holding money from members and their clients that is not actually needed for anything through most of the time.
Richard Wise, Group Chief Risk Officer of the Hong Kong Exchanges & Clearing (HKEX), was one of three participants in the next session, going deeper on the risk models that CCPs work by, and how they are applied. He visually presented the insight as an “impossible triangle for initial margin modelling”. Efficiency, procyclicality and coverage make up the three corners where optimising for any one or two of them is bound to take a toll on the third. He pointed to risk that CCPs who hold extra buffers in “sunny days” might after all turn out dangerously slow in identifying the type of shift to bad weather that should motivate the countercyclical release of those reserves. To support quicker responsiveness, he presented the idea of basing calls not only on observed volatility but also on predictions for upcoming volatility levels that haven’t yet arrived. This can be done by using market information, implicit in market pricing of options in large volumes. He showed a graph as evidence that such predictions have good quality.
Richard Wise shared the stage with Udesh Jha, Head of Post-Trade Services with CME Group, in a session led by Pedro Gurrola Perez, Head of Research with the World Federation of Exchanges.
The alternative paths of regulatory mandates versus commercial self-drive come into question also when it comes to how margin levels are determined.
“We often go over and beyond the regulatory prescriptions,” said Udesh Jha, of the CME Group, whose business ties up margin in the regions around $250 billion. He described how the anti-procyclicality measures are important, so that market swings will not unnecessarily cause regular need for margin calls in the tens of billions of dollars from the market participants in just a day or a few hours.
