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Financial Stability Paper 30: Dear Prudence, won’t you come out to play? Approaches to the analysis of CCP default fund adequacy

David Murphy and Paul Nahai-Williamson ()

No 30, Bank of England Financial Stability Papers from Bank of England

Abstract: Central counterparties (CCPs) are a key feature of the post-crisis financial system, and it is vital that they are robust. Indeed, as Paul Tucker said, ‘it is an understatement that it would be a disaster if a clearing house failed’ (Tucker (2011)). Therefore the question of how safe CCPs are is an important one. A key regulatory standard for CCPs is ‘cover 2’: this states that systemically important clearing houses must have sufficient financial resources to ‘cover’, or be robust under the failure of, their two largest members in extreme but plausible circumstances. This is an unusual standard, in that it is independent of the number of members a CCP has. Therefore it is natural to ask how prudent the cover 2 standard is for different sizes of CCP. This is the question investigated in this paper. We first use a simple model to quantify the likelihood of CCP failure. This model is used to produce stylised results showing how the probability of failure of a CCP that meets the cover 2 standard can be estimated. Second, we present a simple approach to explore how the distribution of risk among clearing members affects the prudence of the cover 2 standard. Our results give some reassurance in that we find that CCPs meeting the cover 2 standard are not highly risky provided that tail risks are not distributed too uniformly amongst CCP members. They do however suggest that CCPs and their supervisors should monitor this distribution as central clearing evolves.

Keywords: financial regulation; central counter parties (search for similar items in EconPapers)
JEL-codes: G28 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2014-10-24
New Economics Papers: this item is included in nep-ban and nep-rmg
Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper30.aspx
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