| (1) |
A licensed central counterparty— |
| (a) |
must effectively measure, monitor and manage its credit exposures to its clearing members and those arising from its clearing processes; |
| (b) |
must identify sources of credit risk5, routinely measure and monitor credit exposures, and use appropriate risk management tools to control these risks, and to assist in this process, a central counterparty must ensure it has the capacity to calculate exposures to its clearing members on a timely basis as required, and to receive and review timely and accurate information on its clearing members' credit standing; |
| (c) |
must frequently and regularly measure and monitor its credit risks throughout the day using timely information |
| (d) |
must ensure that it has access to adequate information to allow it to measure and monitor its current and potential future exposures, including to individual clearing members;6
|
| (e) |
must, in order to estimate the potential future exposures that could result from clearing member defaults, identify risk factors and monitor potential market developments and conditions that could affect the size and likelihood of its losses in the close out of a defaulting clearing members’ positions; |
| (f) |
must regularly monitor the existence of large exposures to its clearing members and, where appropriate, their clearing clients; |
| (g) |
must ensure that its systems are capable of calculating exposures to its clearing members intraday and at short notice; |
| (h) |
must have the capacity to monitor any changes in the creditworthiness of its clearing members through the systematic review of timely information on financial standing, business activities and profile, and potential interdependencies; |
| (i) |
must use the capacity referred to in paragraph (h) to conduct periodic reviews of its clearing members' credit standing, and to conduct ad hoc reviews where the central counterparty has reason to believe that a clearing member's credit standing may deteriorate; |
| (j) |
must mitigate its credit risk to the extent possible;7
|
| (k) |
must have the authority and operational capacity to make intraday margin calls, both scheduled and unscheduled, from clearing members; |
| (l) |
must place limits on credit exposures, even where these are collateralised, and limits on concentrations of positions or additional collateral requirements may also be warranted; |
| (m) |
may use a sequence of prefunded financial resources, referred to as a "waterfall", to manage its losses caused by clearing member defaults, which waterfall may include— |
| (i) |
a defaulter's initial margin; |
| (ii) |
the defaulter's contribution to a prefunded default arrangement; |
| (iii) |
a specified portion of the central counterparty's own funds; and |
| (iv) |
other clearing members' contributions to a prefunded default arrangement; |
| (n) |
must hold a combination of margin and pooled prefunded resources to control credit risks; |
| (o) |
must maintain additional pooled prefunded financial resources to cover a portion of the tail risk; |
| (p) |
must have the authority to impose activity restrictions or additional credit risk controls on a clearing member in respect of transactions with that clearing member where the central counterparty determines that the clearing member's credit standing may be in doubt; |
| (q) |
must cover its current and potential future exposures to each clearing member with a high degree of confidence using margin and other prefunded financial resources on collateral and on margin; |
| (r) |
must document its supporting rationale for, and have appropriate governance arrangements relating to, the amount of total financial resources it maintains; |
| (s) |
must establish initial margin requirements that are commensurate with the risks of each product and portfolio, which initial margin must be designed to meet an established single-tailed confidence level of at least 99% of the estimated distribution of future exposure, provided that for a central counterparty that— |
| (i) |
calculates margin at the portfolio level this requirement applies to each portfolio’s distribution of future exposure; and |
| (ii) |
calculates margin at more granular levels, such as at the sub-portfolio level or product level; the requirement must be met for the corresponding distribution of future exposure; |
| (t) |
must maintain additional financial resources sufficient to cover a wide range of potential stress scenarios involving extreme but plausible market conditions; |
| (u) |
that is involved in activities with a more complex risk profile, such as clearing securities that are characterised by discrete jump-to-default price changes or that are highly correlated with potential clearing member defaults; and |
| (v) |
must maintain additional financial resources sufficient to cover a wide range of potential stress scenarios that must include, the default of the second and third largest clearing members and their affiliates, that would potentially cause the largest aggregate credit exposure for the central counterparty in extreme but plausible market conditions. |
| (2) |
A licensed central counterparty must— |
| (a) |
through rigorous stress testing, determine the amount and regularly test the sufficiency of its total financial resources available in the event of a default or multiple defaults in extreme but plausible market conditions; |
| (b) |
perform daily stress tests, using standard and predetermined parameters and assumptions; |
| (c) |
on at least a monthly basis, perform a comprehensive and thorough analysis of stress-testing scenarios, models and underlying parameters and assumptions used to ensure they are appropriate for determining the central counterparty's required level of default protection in light of current and evolving market conditions; |
| (d) |
perform the analysis of stress testing referred to in paragraph (c) more frequently when the products cleared or markets served display high volatility, become less liquid, or when the size or concentration of positions held by a central counterparty's clearing members increases significantly; |
| (e) |
at least annually perform a full validation of its risk management model9; |
| (f) |
conduct reverse stress tests, as appropriate— |
| (i) |
to test how severe stress conditions would be covered by its total financial resources; |
| (ii) |
aimed at identifying the extreme scenarios and market conditions in which its total financial resources would not provide sufficient coverage of tail risk |
| (g) |
test the adequacy of its initial margin requirements and model, through back testing and sensitivity analysis, respectively; |
| (h) |
in conducting stress testing, consider the effect of a wide range of relevant stress scenarios in terms of both defaulters' positions and possible price changes in liquidation periods, which scenarios should include— |
| (i) |
relevant peak historic price volatilities; |
| (ii) |
shifts in other market factors such as price determinants and yield curves; |
| (iii) |
multiple defaults over various time horizons; |
| (iv) |
simultaneous pressures in funding and asset markets; and |
| (v) |
a spectrum of forward-looking stress scenarios in a variety of extreme but plausible market conditions; |
| (i) |
in constructing stress scenarios, not consider extreme but plausible conditions as a fixed set of conditions, but rather conditions that evolve; |
| (j) |
ensure that its stress tests incorporates, on a timely basis, emerging risks and changes in market assumptions, for example, departures from usual patterns of co-movements in prices among the products a central counterparty clears; |
| (k) |
when proposing to clear new products, consider movements in prices of any relevant related products; |
| (l) |
where projected stress-test losses are frequent and consistently widely dispersed across clearing members, have clear processes in place to augment pooled financial resources. |
| (3) |
In the event that projected stress-test losses exceed available financial resources, a central counterparty must ensure that additional financial resources are obtained on a timely basis;11 ensure that its rules and procedures support timely action to increase financial resources in these circumstances clearly articulate the circumstances in which it will call for additional margin or non-pooled financial resources from clearing members, and both the form, that is, cash or eligible non-cash collateral, and the time frame in which calls must be satisfied;periodically engage with clearing members to ensure that they understand their potential obligations and have taken appropriate steps to ensure that they would be able to meet them. A central counterparty must have clear procedures to report the results of its stress tests to its controlling body and to use these results to evaluate the adequacy of and adjust its total financial resources establish explicit rules and procedures that address fully any credit losses it may face as a result of any individual or combined default among its clearing members with respect to any of their obligations to the central counterparty, which rules and procedures must address how potentially uncovered credit losses would be allocated, including the repayment of any funds a central counterparty may borrow from liquidity providers. Subject to the provisions specified below for the measurement of a central counterparty’s exposure amount or exposure-at-default, risk-weighted exposure and related required amount of capital in respect of instruments, contracts or transactions that expose the central counterparty to counterparty credit risk, the central counterparty must use the current exposure method12 specified in Regulation 29. |
| (6) |
In calculating a central counterparty’s exposure to counterparty credit risk, the exposure amount relating to a particular counterparty must be equal to the sum of the relevant exposure amounts or exposures-at-default calculated in respect of each relevant netting set relating to that counterparty, provided that— |
| (a) |
for purposes of calculating the relevant amount of required capital for default risk in terms of the relevant requirements specified in these Regulations, the relevant outstanding exposure amount must be net of any incurred CVA losses; |
| (b) |
unless specifically otherwise provided for in this Regulation, the relevant outstanding exposure amount for a given OTC derivative counterparty shall be the higher of— |
| (ii) |
the difference between the sum of all relevant exposure amounts or exposure-at-default across all relevant netting sets with the counterparty and the CVA for that counterparty which has already been recognised by the central counterparty as an incurred write-down or incurred CVA loss, which CVA loss shall be calculated. |
| (c) |
the reduction of exposure or exposure-at-default by incurred CVA losses shall not apply in the calculation of the relevant amount of required capital for CVA risk. |
| (7) |
A central counterparty must, in addition to any capital requirements for default risk related to counterparty credit risk, determine the relevant amount of required capital to cover risk related to mark-to-market losses on the central counterparty’s expected exposure to counterparty risk, which losses shall for purposes of these Regulations be referred to as CVA risk or CVA losses in respect of OTC derivatives, provided that— |
| (a) |
the relevant additional required amount of capital for CVA risk in accordance with the relevant requirements and formula specified in Regulation 28; |
| (b) |
the additional required amount of capital for CVA risk shall be a standalone market risk requirement, calculated on the set of CVAs envisaged in paragraph (f) for all relevant collateralised and uncollateralised OTC derivative counterparties, together with eligible CVA hedges, provided that, unless expressly otherwise provided in these Regulations, within the standalone required amount of capital for CVA risk, the central counterparty may not apply any offset against any other instrument on the central counterparty’s balance sheet; |
| (c) |
only hedges used by the central counterparty to mitigate its exposure to CVA risk, and managed as such, shall be eligible for inclusion in the calculation of the central counterparty’s relevant required amount of capital for CVA risk; |
| (d) |
the only hedges eligible for inclusion in the calculation of the central counterparty’s required amount of capital for CVA risk shall be single-name credit default swaps, single-name contingent credit default swaps, other equivalent hedging instruments referencing the counterparty directly, and index credit default swaps, that is, counterparty risk hedges other than the instruments specified above shall be excluded from the calculation of the central counterparty’s relevant required amount of capital for CVA risk; |
| (e) |
no tranched or nth-to-default credit default swaps shall constitute an eligible CVA hedge; |
| (f) |
any eligible hedge included in the relevant required amount of capital for CVA risk shall be removed from the central counterparty’s relevant calculation of required capital for market risk; |
| (g) |
the central counterparty must exclude from the additional required amount of capital for CVA risk— |
| (i) |
transactions with a central counterparty; and |
| (ii) |
securities financing transactions, provided that when securities financing transactions exposures are deemed by the Authority to be material, the Authority may in writing instruct a central counterparty to include in its relevant calculations CVA loss exposures arising from securities financing transactions. |
5 The default of a clearing member (and its affiliates) has the potential to cause severe disruption to a central counterparty, its other clearing members and the financial markets more broadly. Therefore a central counterparty should establish a robust framework to manage its credit exposures to its clearing members and the credit risks arising from its clearing processes. Credit exposures may arise in the form of current exposures, potential future exposures, or both. The type and level of credit exposure faced by a central counterparty will vary based on its design and the credit risk of the counterparties concerned.
6 Current exposure is relatively straightforward to measure and monitor when relevant market prices are readily available. Potential future exposure is typically more challenging to measure and monitor and usually requires modelling and estimation of possible future market price developments and other variables and conditions, as well as specifying an appropriate time horizon for the close out of defaulted positions.
7 For example, to control the build-up of current exposures, a central counterparty should require that open positions be marked-to- market and that each clearing member pay funds, typically in the form of variation margin, to cover any loss in its positions' net value at least daily; such a requirement limits the accumulation of current exposures and therefore mitigates potential future exposures
8 Initial margin is used to cover a central counterparty's potential future exposures, as well as current exposures not covered by variation margin, to each clearing member with a high degree of confidence. However, a central counterparty generally remains exposed to residual risk (or tail risk) if a clearing member defaults and market conditions concurrently change more than is anticipated in the margin calculations. In such scenarios, a central counterparty's losses may exceed the defaulting clearing member's posted margin. Although it is not feasible to cover all such tail risks, given the unknown scope of potential losses due to price changes.
9 Stress scenarios, models and underlying parameters and assumptions should be examined based on historical data of prices of cleared products and clearing members' positions and potential developments of these factors under extreme but plausible market conditions in the markets that the central counterparty serves.
10 Reverse stress tests require a central counterparty to model hypothetical positions and extreme market conditions that may go beyond what are considered extreme but plausible market conditions in order to help understand margin calculations and the sufficiency of financial resources given the underlying assumptions modelled. Modelling very extreme market conditions can help a central counterparty determine the limits of its current model and resources. However, it requires the central counterparty to exercise judgement when modelling different markets and products. A central counterparty should develop hypothetical very extreme scenarios and market conditions tailored to the specific risks of the markets and of the products it serves. Reverse stress testing should be considered a helpful management tool but need not, necessarily, drive the central counterparty's determination of the appropriate level of financial resources.
11 The nature of the additional financial resources called may depend on the distribution of projected stress-test losses. If projected stress-test losses exceed available financial resources for only a single, or few clearing members, then it may be appropriate to call for additional margin or other non-pooled financial resources from those clearing members.
12 The current exposure method must be available only for the measurement of the reporting central counterparty’s exposure to counterparty credit risk arising from OTC derivative instruments, that is, exposure to credit risk arising from securities financing transactions shall be calculated, amongst other things, in accordance with the relevant requirements specified in Regulations 29 the central counterparty’s exposure to counterparty credit risk, when the central counterparty purchases credit derivative protection against an own book exposure or against an exposure to counterparty credit risk, the central counterparty shall in respect of the hedged exposure calculate its required amount of capital in accordance with the relevant requirements relating to credit derivative instruments.
National Environmental Management Act, 1998 (107 of 1998)
