Our Risk Management Philosophy
RepoClear’s risk management aims to ensure that any member default can be handled with the existing resources and with minimal disruption to the market.
In order to be confident that we can maintain the safety and stability of Clearing Members and clients, the service has built a framework of safeguards, underpinned by state-of-the-art risk models.
The various layers of protection ensure that we have adequate financial resources to fulfil these obligations in all circumstances – most importantly, to protect cleared trades at our clearing house and the collateral posted against them.
Safety and Stability: Risk Management at RepoClear
Risk management and settlement is at the core of everything we do here at RepoClear.
It starts with the onboarding process, where we assure that a new Clearing Member has the capabilities to participate in the market and manage their positions.
That philosophy then runs through every step of the clearing process at our CCP and all the way to the settlement of a Clearing Member default.
Membership Criteria
As our first line of defence, RepoClear sets stringent and transparent eligibility requirements for prospective Clearing Members.
The Margin Framework
A comprehensive Margin framework covers the Initial and Additional Margin requirements, the mark-to-market in the form of Variation Margin.
Initial and Additional Margin
The risks associated with the closeout of a member’s position are covered through the Initial Margin and Additional Margins. The core Initial Margin, depending on the type of instrument, uses an analytical (VAR/Expected shortfall) model or a PIMM (Parametrical Initial Margin Model) model both based on historical market moves. Additional Margin covers various forms of risks such as concentration risks, idiosyncratic risks and positions with high-stress losses compared to the mutualised resources.
Default Management
In the event of a Clearing Member default, these pre-emptive safeguards dramatically limit the impact arising from the failure. The defaulted portfolio could be hedged with the guidance of the Default Management Group to reduce its risk, and then auctioned off.
Default Fund
Following the Clearing Member failure, our default waterfall model dictates that the entity’s posted margin and default fund contributions are the first resources to be consumed. Only after these resources are exhausted across all services and LCH’s own “skin in the game” is consumed, would non-defaulting Clearing Members begin to experience losses.
In the next section, we go into more detail about precisely how we would manage a member default.
Default Management Process
RepoClear maintains a rigorous default management process.
The process is tested regularly in Firedrills which involve members.
Our default management process follows three steps to reduce the risk of the defaulted firm’s outstanding positions without impacting other non-defaulting Clearing Members:
Risk Neutralisation: After a member default, the Default Management Group, which apart from the LCH staff also includes representatives of members in an advisory role, is convened. This group advises on the various steps of the default management process.
Portfolio Auction: After that step, RepoClear could split the remainder of the defaulter’s portfolio into auction portfolios. An auction is then conducted for each portfolio with members who are major participants in the respective markets.
Loss Attribution: In the event that losses are greater than the financial resources of the defaulting member and of LCH, the funded Default Fund contributions of solvent RepoClear members are used.
RepoClear’s Default Waterfall
RepoClear’s default waterfall establishes the order in which the financial resources of a defaulted Clearing Member, solvent Clearing Members and the resources of LCH itself are consumed during a default resolution.
A defaulting Clearing Member’s posted margin is the first asset to be consumed in managing the default, followed by the defaulter’s contribution to default funds.
If these assets prove insufficient to settle the default, LCH’s own capital is next in line for losses. It is only after all of these resources are exhausted that default fund contributions from non-defaulting Clearing Members are used to close out the portfolio.
In the extreme event that all waterfall resources are consumed and defaulted positions have not been fully auctioned, we will enter a service continuation phase and potentially a service closure phase.
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