UniCredit's Mustier ‘frightened’ by CCP capital levels

Italian bank's head of investment banking says he is worried by the low capital levels at Eurex and LCH.Clearnet, and suggests CCPs should not be for-profit entities. Clearing members are also pushing CCPs to boost their capital

Jean Pierre Mustier, UniCredit

UniCredit's head of corporate and investment banking is "frightened" by the low capital levels at central counterparties (CCPs) such as Eurex and LCH.Clearnet and has suggested that users should either provide unlimited contingent funding for CCPs or that clearing should not be run for profit at all.

"We are moving from interdependence of banks in terms of derivatives that are traded between banks, which have €1.6 trillion of capital, towards concentrating all the derivatives exposure in CCPs, which have €1.2 billion of capital. When I look at it this way, I'm not impressed," said Jean Pierre Mustier, speaking at the annual meeting of the International Swaps and Derivatives Association in Munich this morning.

UniCredit's exposures to Eurex and LCH.Clearnet are three times larger than its next largest exposure, Mustier said. He added that when he raises concerns about capital levels with the heads of the two CCPs, they claim their internal models are sophisticated enough to manage the risks. Mustier said he was not reassured.

"That's where I come to be frightened actually. It's not because we have a good model that we don't have the risk. By creating these concentrations we could... create more risk in the future. And we need to be careful," he said.

To combat the problem, he said CCPs should either look for unlimited contingent capital from users to boost capital levels, or perhaps not even be run for profit at all: "Maybe they should not be for-profit [entities], because when they're for-profit they push things maybe to the extreme," he said.

Maybe they should not be for-profit, because when they're for-profit they push things maybe to the extreme

Speaking to reporters after Mustier's keynote address, Robert Pickel, chief executive officer of Isda, said he would not advocate making CCPs public utilities, but argued they should at least be viewed through that lens.

"They can't just be run for profit - there is so much at stake here that one has to look at it through that utility lens even though we understand they are for-profit entities," said Pickel.

Isda chairman Stephen O'Connor said Mustier's concerns about CCP capital levels are valid, given the importance of the clearing houses to the integrity of the global financial system. But he added it is in clearing members' interests to ensure the capital and margining approach of a CCP is adequate.

"[The banks] are not negotiating for lower margin on the other side of that trade. So the interests of the members are effectively aligned with regulators as they have all this money at risk - the last thing they want is a default, so there's extra diligence going on on the part of the members," said O'Connor.

Mustier's comments are the most public in a growing push for CCPs to increase the capital they put into their so-called default waterfalls, which are intended to absorb losses resulting from the default of clearing members.

During the drafting of Europe's mandatory clearing rules – the European Market Infrastructure Regulation – banks called for CCPs to be required to put up capital equivalent to 30% of the money contributed by members to the clearing house default fund, meaning the clearing house would have to contribute more equity as the fund size increased. The push was unsuccessful and clearing house capital requirements are subject to a lower ratio.

"CCPs fought very hard to make sure such a rule would not be implemented as they didn't want to put their shareholders' equity at risk, citing solvency concerns, even though they are the people who are doing the risk management that determines whether the CCP blows up or not," says one head of over-the-counter derivatives clearing.

Another clearing specialist at a UK bank in London agrees CCPs should be required to have more skin in the game – not only to ensure they can withstand clearing member defaults, but also to make sure they are held responsible for their own operational mistakes.

"The main aim of the CCP skin-in-the-game requirement is to align interests and make the CCP suffer a loss when it gets the risk management wrong. If the tranche is too small, the incentive might not be large enough," he says.

Clearing members have another incentive to make this argument – more capital from the CCP would translate into lower default fund contributions and regulatory capital charges for the banks. But members argue that safety, rather than savings, is the primary motivation. Even if CCPs were required to increase their contributions, it would not make a big dent in the costs facing clearing members, they argue.

"You have to think about the impact. How much would it reduce the default fund contributions if the CCP increases its participation by a given amount? Especially in the case of incumbents, the increased CCP participation will need to be large to impact the required default fund," says one European head of OTC clearing at a bank in London.