Margin Calls From Clearinghouses Seen Stoking Future Crises

Use of central clearing was seen a fix after 2008 crisis

by Greg Ritchie and Liz Capo McCormick

Central clearinghouses that hold over $1 trillion in liquid assets may exacerbate periods of financial stress, creating “margin spirals” that can push down asset prices, according to researchers from the Bank for International Settlements.

The researchers focused on the impact when the central counterparty clearinghouses, known as CCPs, increase initial margin requirements for its members during times of stress. This may lead to “fire sales” in cash and derivative markets as investors dump assets to raise the needed funds, increasing volatility further and triggering additional rounds of margin calls, the paper notes.

The researchers also raised concern over clearinghouses’ $600 billion holdings of government bonds. The dual role of such assets — which can act as both the collateral backing a trade and the underlying asset behind a derivatives transaction — creates a “wrong way risk” in a selloff when the diminishing value of collateral encourages further sales.

“CCPs currently manage a large pool of liquid assets, which supports financial stability by safeguarding them from counterparty risk,” said the researchers Iñaki Aldasoro, Fernando Avalos and Wenqian Huang. “At the same time, risk does not disappear but morphs into systemic liquidity risk, especially in a context of margin spirals.

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Total collateral in global CCPs amounted to $1.3 trillion as of mid-June, made up predominately of cash — which includes items such as deposits held at central banks and reverse repurchase agreements - and government bonds, the BIS estimated. That stockpile was equivalent to about 10% of all high-quality liquid assets held by global systemically important banks.

Settling transactions through central clearinghouses was one of the key objectives of market regulations following the global financial crisis that sought to vanquish the risk that the blow up of one firm would cause a systemic shock like the one that followed the Lehman Brothers collapse. Even now, US regulators are pushing for hedge funds to start centrally clearing many of their transactions in Treasuries.

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