The World Federation of Exchanges Publishes New Research on the Measurement of Procyclicality of CCP Margin Models
London, 18 May 2023 – The World Federation of Exchanges (“The WFE”), the global industry group for CCPs and exchanges, today published new research on measuring the procyclicality of CCP initial margin models.
The Working Paper by WFE Research studies the standard measures of initial margin model procyclicality, which are random variables subject to uncertainty. To date, this random element has drawn little attention but has significant consequences, as the ability to adequately measure the responsiveness of a model is fundamental to the discussion and implementation of any procyclicality mitigation tool.
Therefore, to be robust, any decision or policymaking based on these measures must consider the impact that uncertainty will have on expected outcomes. The WFE Research Working Paper aims to estimate such impact, examining the case of some typical margin models, both empirically and within a Monte Carlo simulation setting.
Initial margin models are a fundamental part of CCPs' management of counterparty risk: margin requirements ensure that the exposure to a failing member is sufficiently collateralised and, in this way, contributes to the CCP buffer against financial contagion. On the other hand, attempts to mitigate procyclicality by altering the responsiveness of a margin model are limited by the fact that models need to be risk sensitive to ensure that the CCP remains adequately collateralised at all times, and by the need to keep central clearing economically efficient. The results presented in the WFE Research Working Paper show that, in addition to the above limitations, there is a significant amount of uncertainty when measuring model responsiveness. This has important implications:
• To be robust, a decision or policy-making process based on the standard procyclicality measures requires quantifying the presence of uncertainty in the measurements, for example, by estimating the sensitivity to the choice of scenario.
• From a policy perspective, without quantifying the uncertainty surrounding procyclicality measurements, there is a risk of prescribing rules with an unknown but significant chance of resulting ineffective.
• It is also difficult to judge whether a behaviour that may be deemed “too procyclical” in one particular scenario reflects a failure of the model's anti-procyclicality credentials or is the likely consequence of the uncertainty in the measurements.
• When estimating the trade-off between costs, procyclicality, and risk sensitivity, the additional parameter uncertainty that some anti-procyclicality (APC) tools bring, plus the uncertainty in the estimation of costs, increases the probability that, in some future scenarios, these APC tools could be inefficient, or even detrimental, from a cost-benefit perspective.
• The greater the uncertainty in responsiveness measurements, or the more sensitivity to the underlying scenario, the less certainty we can place on the benefits of approaches to mitigate future responsiveness based on one-fits-all, hard-rules.
Pedro Gurrola-Perez, Head of Research at the WFE and the author of the paper, said: “Without doubt, CCPs should continue adopting margin arrangements that, ‘to the extent practical and prudent, limit the need for destabilising, procyclical changes’, as established in the PFMIs. But, as this paper shows, uncertainty in model procyclicality forecasts limits what can be achieved through model-focused, hard-rule approaches. It underlines the importance of expert judgement to address model responsiveness on a case-by-case basis.”
Nandini Sukumar, Chief Executive Officer at the WFE, said: ‘’The WFE Research Working Paper shines a light on a little studied, yet critical, element of margin models. We believe that policy positions should always be based on fact, empirical evidence and data. As an industry and organisation, we look forward to engaging in conversation with our stakeholders on the findings of the paper.’’
Please click here to read the paper in full.
About the WFE:
Established in 1961, the WFE is the global industry association for exchanges and clearing houses. Headquartered in London, it represents 250 market infrastructure providers, including standalone CCPs that are not part of exchange groups. Of our members, 25% are in Asia-Pacific, 58% in EMEA and 17% in the Americas. WFE’s 91 member CCPs collectively ensure that risk takers post some $1.3 trillion (equivalent) of resources to back their positions, in the form of initial margin and default fund requirements. WFE exchanges are home to 57,656 listed companies, and the market capitalization of these entities is over $101.17 trillion; around $146.29 trillion (EOB) in trading annually passes through WFE members (at end 2022).
The WFE is the definitive source for exchange-traded statistics and publishes over 350 market data indicators. Its free statistics database stretches back more than 40 years and provides information and insight into developments on global exchanges. The WFE works with standard-setters, policy makers, regulators and government organisations around the world to support and promote the development of fair, transparent, stable and efficient markets. The WFE shares regulatory authorities’ goals of ensuring the safety and soundness of the global financial system.
With extensive experience of developing and enforcing high standards of conduct, the WFE and its members support an orderly, secure, fair and transparent environment for investors; for companies that raise capital; and for all who deal with financial risk. We seek outcomes that maximise the common good, consumer confidence and economic growth. And we engage with policy makers and regulators in an open, collaborative way, reflecting the central, public role that exchanges and CCPs play in a globally integrated financial system.