The CFTC released a staff report detailing the results of an evaluation of settlement liquidity at three major clearinghouses. The report examined the ability of the clearinghouses to meet settlement obligations in the event of extreme market stress. The report was the second in a series of stress-testing exercises (the first report was released in November 2016).

In the report, the CFTC evaluated CME Clearing, ICE Clear U.S., and LCH, Ltd. The hypothetical scenario involved the closing of two significant clearing members, and the CFTC evaluated whether the tested clearinghouses would be able to generate sufficient liquidity to satisfy variation margin obligations. The CFTC found that:

  • all tested clearinghouses were able to demonstrate the ability to generate sufficient liquidity to satisfy settlement obligations;
  • the clearinghouses all used different combinations of methods to generate funds; and
  • in the instances where clearinghouses used the same methodologies, such overlap did not present any systemic risk concerns.

According to the CFTC, these results should mitigate some concerns about liquidity risk at clearinghouses. The CFTC will continue to conduct such stress tests, and identified trading liquidity, operational risk and the potential failure of a settlement bank as areas of future focus. Finally, the CFTC committed to automating its stress-testing process to allow for more frequent testing.

Commentary / Bob Zwirb

The Report applies conservative assumptions to events that could plausibly take place during a period of extreme stress. As such, it lends credibility to the CFTC's judgment that clearinghouses would be able to obtain the funds necessary to meet their settlement obligations during a period involving the simultaneous default of two large clearing members. As with the first stress test, the CFTC was careful to highlight the exercise's limitations, including the fact that it did not address the liquidity of the underlying derivatives markets, i.e., the ability of a clearinghouse to hedge and to liquidate the positions of a defaulting clearing member, something that the agency intends to test in the future. It also begs the question what happens when there are more than two significant clearing members who default in a period of financial stress akin to the one experienced in 2008.

It should be noted that the CFTC test is limited to the clearinghouse directly, and not to the effect of the clearinghouses on the rest of the financial system. The problem with this is that the clearinghouses may be able to survive because, given their favored status in the regulatory hierarchy, they are able to pull liquidity out of other financial participants, which may wreak havoc on the markets generally, even while the clearinghouses stay afloat. It is interesting that the report came out on the same day that Gary Cohn, director of the White House's National Economic Council, questioned the enhanced role of clearinghouses in the financial markets, calling them "a new systemic problem in the system."

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