CFTC Chair Timothy Massad spoke at the Future Industry Association Conference in Boca Raton. In his keynote address, Chair Massad focused on ways the CFTC addresses clearinghouse resiliency.
As clearinghouses become integral to the financial system, Chair Massad stated, the risks they pose to the system overall must be acknowledged and considered by regulators. He highlighted certain “increasing” concerns involving clearinghouses, including (i) assessing the adequacy of recovery plans, (ii) ensuring that clearinghouses have enough capitalization, or “skin in the game,” and (iii) addressing whether the potential liability of clearing members is “properly sized or capped.”
Ultimately, Chair Massad explained, the CFTC’s regulatory goal for clearinghouses is to create a framework that is designed to “strengthen the risk management practices” of derivatives clearing organizations (“DCOs”), “promote financial integrity for swaps and futures markets, and enhance legal certainty for DCOs, clearing members, and market participants.” He reported that CFTC regulations for clearinghouses are consistent and current with the Principles for Financial Market Infrastructures (“PFMIs”) published by CPMI-IOSCO in 2012.
Chair Massad explained that creating written standards for clearinghouses is a start, but that the CFTC must engage in “extensive” oversight activities – such as daily risk surveillance, analysis of margin models, stress testing, back testing and in-depth compliance examinations – to supervise clearinghouses properly.
Chair Massad went on to stress that regulators must look at the “full picture” when considering issues pertaining to risk mitigation. He stated that capitalization issues for a clearinghouse should be viewed in the context of its overall financial resources, and reasoned that both initial margin and default fund contributions are not enough to cover losses in certain situations. Additionally, he acknowledged that circumstances might arise in which a clearinghouse faces risks beyond that of a default by a clearing member, and regulators have required that clearinghouses maintain capital or other resources sufficient to cover operating costs for one year.
Chair Massad praised the CFTC’s clearinghouse policies overall, and noted that more can be done with respect to the frequency of examinations.
Lofchie Comment: The risk that needs more attention is a clearinghouse’s demand for more margin in a period of falling prices and declining liquidity – a demand that has the potential to lead to a massive and rapid sell-off of assets. The requirement that clearinghouses maintain sufficient capital to cover one year of operation is trivial in light of the potential cost of the economic risks that flow through a clearinghouse.