Are CCPs here to manage risk or instead to cause it? •Changing environment: security vs capital efficiency •Diversity killed by regulation? •CCP default scenario: recovery vs resolution 2

1. Risk Management in the Field of CCPs
Post Trade Forum – Vienna – 10-11 September 2015
By Giuseppe Insalaco, Markets Policy Division, Market Infrastructure Unit, Central Bank of Ireland

2. Table of contents
• Are CCPs here to manage risk
or instead to cause it?
• Changing environment: security
vs capital efficiency
• Diversity killed by regulation?
• CCP default scenario: recovery
vs resolution
2
The speaker:
• Senior advisor, Central Bank of Ireland
– Markets Policy Division
– market infrastructure (CCPs, CSDs),
trading venues, shadow banking, HFT,
virtual currencies, Crowdfunding
• Drafting Level 2 regulation (ESMA
PTSC, ESAs TFMI)
• Advisor to Department of Finance re
CCP Recovery and Resolution dossier
The Customary Disclaimer
1. This is not investment advice,
or regulatory guidance
2. This is not “The BANK”, just
me
3. Don’t do as I say, don’t listen
to me anyway

3. Are CCPs the cure or the problem?
• CCPs are designed to solve a
problem, not all problems;
• The technology used by CCPs
has limitations, and (minor)
side-effects;
• As CCPs usage grows, minor
side-effects become large; very
large;
• We are working to mitigate the
side-effects.
3

4. Horses for Courses
The Problem:
• Bilateral counterparty credit risk:
– Trading with “strangers”
– Offsetting/netting across different
counterparties
The Solution:
• Riskless principal creditworthy
middleman
The Technology:
• Poker Rules:
– Settle losses after each round, in cash
– Pre-funding of all bets
4
CCP Risk Management Program:
1) Value all positions
2) Collect all profits in cash
3) If failed collections > 0 then:
A. Identify defaulter
B. Appropriate defaulter “pre-paid losses
fund”
C. Liquidate all defaulter's positions
D. Cover all execution shortfalls using
defaulters “pre-paid losses fund”
E. Terminate defaulter
4) Pay out all losses in cash
5) Goto 1

5. Are CCPs Effective?
5
-30
-20
-10
0
10
20
30
Pros

6. Side-effects of Cashification
VM exchanged in
cash
IM is cash-like
instruments
CCP has vast inventory of highly
liquid IM deployable instantly
DCF also highly liquid and quickly
deployable
Cash is the solution….
… but it’s not problem-free
6
Liquidity as proxy for solvency:
– Dependency on liquid markets
and functioning repo facilities
– Problem of reinvestment
– Dependency on collateral quality
– Contagion channel to all asset
classes

7. Security vs Capital Efficiency
7
Capital to address liquidity:
The CCP risk management is highly
time-sensitive and very rigid (automatic).
• Capital buffers in cash
• CCP skin in the game
• GCM capital guarantee to clients
• Spare capacity (haircuts & add-ons)
• Ban on re-use or re-hypothecation
Cash, in liquid form, is unproductive
capital …
NB: this is a deliberate design feature
(superseniority)

8. Diversity Killed by Regulation?
8
• CCPs are not islands, they are
nodes in a complex web
• Multi-functionality of Banks:
GCMs, liquidity providers, clients
• Cleared + OTC business + collateral
Same standards, same triggers,
same parameters… clones.

9. Cost of Creditworthiness: the Waterfall
9
Defaulter
Pays Endogenous
mutualisation HIC SUNT LEONES
• The transition point between
phases is arbitrary
• Social trade-off between
regimes (members vs clients)
• The issue of for-profit CCPs
• The cost of “punishing” moral
hazard
EMIR operating zone

10. CCP Default
10
The Land beyond EMIR:
CCP killers:
• Multiple GCM default
• Loss on investment (collateral downgrade)
• Loss of clients
Where is the money?
• Surviving GCM capital
• Client IM
• Taxpayer
What happens next?
• Recapitalise & keep it going
• Disentangle & distribute bilaterally
• Tear-up
Price of competition is failure: not if…
when.
Cannot build unsinkable ships
Remember: all money is gone

11. Conclusions
• CCPs are designed to solve a
problem, not all problems;
• The technology used by CCPs
has limitations, and (minor)
side-effects;
• As CCPs usage grows, minor
side effects become large; very
large;
• We are working to fix the
problem
11