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Page 1 © 2009 Thomas Murray Ltd. AMEDA Leadership Forum Alexandria, Egypt, 27-29th April CCPs and other Risk Containment Models.

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Presentation on theme: "Page 1 © 2009 Thomas Murray Ltd. AMEDA Leadership Forum Alexandria, Egypt, 27-29th April CCPs and other Risk Containment Models."— Presentation transcript:

1 Page 1 © 2009 Thomas Murray Ltd. AMEDA Leadership Forum Alexandria, Egypt, 27-29th April CCPs and other Risk Containment Models

2 Page 2 © 2009 Thomas Murray Ltd. What is Counterparty Risk? What is a Central Counterparty (CCP)? Advantages and Disadvantages of a CCP? CCP Risk Models and Alternatives Agenda

3 Page 3 © 2009 Thomas Murray Ltd. ‘The risk that a counterparty will not settle its obligations for full value at any time’ i.e. will default on a contract. Two components to potential losses: Principal (or Direct) Loss: loss of securities or cash value where one part has delivered (with finality) and the other does not. Consequential Loss: indirect losses caused by inability to settle transactions due to default of a counterparty (e.g. loss of liquidity, missed corporate action, loss of profit for onward sell, costs incurred to cover a short generated by the fail, penalties due to short position generated etc). Importance of controlling counterparty risk exposures has risen significantly post-Lehmans. What is Counterparty Risk?

4 Page 4 © 2009 Thomas Murray Ltd. What is a Central Counterparty (CCP)? A CCP is “an entity that interposes itself between counterparties to contracts in one or more financial markets, becoming the seller to the buyer and the buyer to the seller” CPSS/ IOSCO Recommendations for Central Counterparties November 2004 CCP defined by legal/contractual obligations for transactions it clears, NOT by function. Central Novation or Open Offer are main legal mechanisms. A CCP ultimately takes Counterparty Risk on itself, as opposed to mutualising the risk exposure amongst its members.

5 Page 5 © 2009 Thomas Murray Ltd. Disadvantages – Enormous concentration of risk means CCPs become systemically critical Risk model only as good as the algorithms and quality of collateral Another layer of cost Netting diminishes CSD settlement revenues Exposures to CCP – credit risk, operational risks Requires ‘water-tight’ legal framework for netting, margins/collateral and finality. Only covers T+3 settlement Advantages and Disadvantages of a CCP Advantages - Don’t have to worry about the credit risk of your counterparty Quasi-utility status of CCP may mitigate political risks of intervention Risk is centralised and transparent so can be managed more efficiently Provides legal foundation for certainty of settlement guarantee Provides for settlement anonymity Needed for order-driven markets where brokers are weak

6 Page 6 © 2009 Thomas Murray Ltd. Example Risk Model: LCH Clearnet (UK and Euronext). Strict membership criteria ensures high quality counterparties Real-time novation/ Open Offer of cash market trades Clearing members become the ‘Principal’ to trades Multilateral netting to reduce value at risk Initial and variation margins marked to market Intraday margin calls Clearing fund to cover risk in abnormal market positions Buy-in/Sell-out (BiSo) capabilities Secure Payments system Was using insurance policy against default (until December 2008) NB. Risk model only covers the Clearing Members, NOT their clients. Clients have exposure to their Clearing Member. CCP Risk Models and Alternatives

7 Page 7 © 2009 Thomas Murray Ltd. CCP Risk Models and Alternatives CCPCCP LiteClearing House Settlement Guarantor Legal Novation/Open Offer Centralises Risk Technical Novation/Open Offer Anonymous Settlement Clearing Member Structure Member Screening/Monitoring Margin Calculation & Collection Mutualises Risk Multilateral Netting Guarantee Fund Fails Management

8 Page 8 © 2009 Thomas Murray Ltd. CCP – USA, Euronext, Germany, UK, Italy, Japan CCP Lite – Poland, Hungary, Austria, Canada Clearing House – Russia, Korea, Pakistan, Turkey Settlement Guarantor – Greece, Cyprus, Spain, Egypt, South Africa CCP Risk Models and Alternatives


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