Clearinghouses should cap the amount members will have to contribute to replenish a default fund in the case of a failure, Deutsche Bank’s systemic risk management director Robert Lee said on the 2012 International Swaps and Derivatives Association North America Conference in New York last week.
“I think there have been instances where you can say the number of assessments is pretty much uncapped. Typically people have described that as the ‘good till last drop model’,” Lee said. This will create systemic risk, by first aggregating all the risks of OTC derivatives in a clearinghouse and then obligating various interconnected clearing members to contribute additional resources once the clearinghouse fails. It also creates a moral hazard that clearinghouses may not model properly to reduce its clearing members’ risk, according to Lee.
What regulators have to consider is if clearing entities will be forced to contribute unlimited amount to the default fund, or if clearinghouses themselves are allowed to fail. And if that happens, how will the impact be mitigated. “The effort should be focused upon making sure the modeling is robust enough with stress testing and backtesting to ensure that there is a very low degree of risk that you will come to this eventuality. I think what you could do is to put in a mechanism to have a somewhat orderly wind-down at clearinghouse,” Lee concluded.