ESMA has released its framework for stress tests for central counterparties (CCPs), as required under the European Markets Infrastructure Regulation (EMIR).
The European securities markets watchdog is responsible under this regulation for co-ordinating risk assessment to evaluate the safety and resilience of EU CCPs, along with third-country CCPs (known by the EU as Tier 2 CCPs) providing services in the European Economic Area.
The 2021 Stress Test, which is the fourth iteration of its evaluation framework, draws on experience gained from previous evaluation exercises, for example by including an intraday exercise for credit assessment and by evaluating a combination of credit losses and concentration costs when liquidating a defaulting portfolio.
For the first time, this framework also evaluates operational risk.
Commenting on the framework, ESMA chair of the CCP supervisory committee Klaus Löber says, “We have developed the credit and concentration components from the last exercise to provide a more aggregated view of both these risks and introduced a new operational risk analysis with the objective of assessing risks from shared service providers.”
“Last year demonstrated that financial systems are constantly evolving and subject to disruptions such as Covid-19 or Brexit. In that context, it is important to assess that EU CCPs, but also Third Country CCPs of systematic relevance to the EU, are resilient as key infrastructures for EU financial stability.”
The 2021 exercise will be applied to the 13 CCPs authorised to operate in the EU, along with two UK CCPs classified as Tier 2, notably LCH Ltd and Ice Clear Europe Ltd.
With the addition of operational risk, the stress test will now focus on four elements. Credit stress is a measure of a CCP’s ability to absorb losses through a combination of market price shocks and member default. Concentration risk considers the effect of liquidation costs emanating from concentrated positions.
ESMA’s reverse credit stress methodology progressively increases the number of defaulting entities, and the degree of shock or liquidation costs, to identify when CCPs resources are exhausted.
Finally, its operational risk criteria evaluate risks deriving from shared service provision in the clearing segment and interconnectivity between CCPs.