Managing Market Liquidity Risk in Central Counterparties

19 Pages Posted: 20 Jul 2017

Date Written: June 2017

Abstract

In the event of a clearing member’s default, and as part of its default management process, a central counterparty (CCP) will need to hedge the defaulter’s portfolio and to close-out its positions. However, the CCP may not be able to do this without incurring additional losses if the market is illiquid or if the portfolio contains large and concentrated positions. To mitigate this liquidity risk, CCPs often require members to post additional collateral to the initial margin, in the form of “concentration add-ons”. In the absence of a quantitative regulatory standard for calculating concentration add-ons, this paper discusses the different approaches to incorporating market liquidity risk within a CCP’s default waterfall and the challenges that these approaches pose.

Keywords: Central Counterparties (CCPs); Initial Margin; Liquidity Risk; Concentration Add-Ons; Margin Period of Risk (MPOR)

Suggested Citation

Benos, Evangelos and Wood, Michael and Gurrola-Perez, Pedro, Managing Market Liquidity Risk in Central Counterparties (June 2017). Available at SSRN: https://ssrn.com/abstract=3003564 or http://dx.doi.org/10.2139/ssrn.3003564

Evangelos Benos

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Michael Wood

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Pedro Gurrola-Perez (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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