The European Securities and Markets Authority (ESMA) has published the results of its third stress test exercise for the EU’s 16 central counterparties (CCPs) which found that “concentrated positions represent a significant risk”.
The exercise assesses credit, liquidity along with the new concentration risk component, and aims at assessing the losses that may arise when liquidating concentrated positions.
Two default scenarios were run, combined with the common market stress scenario, on two different reference dates: 21 December 2018 and 8 March 2019.
The first scenario involved the default of two clearing member groups under common price shocks is assumed separately at each CCP.
The second scenario is the EU-wide and involves a default of the same two groups for all CCPs EU-wide, designed to assess the resilience of CCPs collectively to the market stress scenario.
The results show that in the first scenario there was no shortfall of pre-funded resources at any CCP, while on the second, one CCP exhibited a shortfall of pre-funded resources which would have to be covered with additional non-pre-funded resources.
For the new risk component showed that, for most asset classes, concentrated position risk is clustered in one or two CCPs, which ESMA says it is unable to name publicly.
Based on the sensitivity data provided by CCPs, the market impact (liquidation cost) was computed for all identified concentrated positions on one reference date (8 March 2019).
At EU level, ESMA warns, the largest concentration risk can be found in fixed income, with around €20 billion.
Concentration in commodity derivatives and in the equity segment (securities and derivatives) is also significant, with around €9.5 billion of concentration risk.
This is the first time that ESMA has included a review of concentration risk as part of its annual stress tests which are required under the European Market Infrastructure Regulation.
Despite the findings, ESMA says the results confirm the overall resilience of EU CCPs to common shocks and multiple defaults for credit, liquidity and concentration stress risks.
“The credit stress test highlighted differences in resilience between CCPs under the selected market stress scenario, although no systemic risk has been identified. Similarly, the liquidity stress test showed EU CCPs to be resilient under the considered scenarios and did not reveal any systemic risk,” ESMA notes.
ESMA’s chair Steven Maijoor says: “CCPs are at the heart of the financial system and the failure of one CCP has the potential to cause serious systemic risk across the EU. Therefore, testing whether CCPs can withstand extreme scenarios involving clearing member defaults and simultaneous market price shocks is an important supervisory tool in mitigating systemic risk.
“The CCP stress test remains a key supervisory tool for EU regulators in ensuring systemic resilience, financial stability and orderly markets. The importance of this tool was recognised in the EMIR review and has been extended to cover systemically important tier two third-country CCPs in future.”
The European Association of CCP Clearing Houses (EACH) has recognised the CCP stress tests.
EACH confirmed that the results of the test prove resilience to common shocks and several defaults for credit, liquidity, and concentration stress risks. In addition, no systemic risks were identified in any scenarios.
The association explained that the current COVID-19 pandemic demonstrates the strength of European CCPs, which continue to operate under their business continuity planning measures despite increased market volatility and operational risk.
