JP Morgan exec challenges CCPs over skin in the game

"Why wouldn't you put up... all of your capital?" asks Olsen

JP Morgan is pushing CCPs to contribute more default capital

Amid a growing clamour for clearing houses to stump up more loss-absorbing capital, the head of JP Morgan's clearing business has suggested central counterparties (CCPs) should allow all their capital to be wiped out before emergency measures impose losses on end-users.

"For all of our customers, we put all of our capital between a default and the clearing house – 100%. It doesn't stop there, though. We are also asked to contribute to the guarantee fund for risks we didn't introduce," said Dave Olsen, global head of clearing at JP Morgan, speaking on a panel on CCP recovery and resolution at a conference run today (September 17) by the International Swaps and Derivatives Association in New York.

Turning to the CCPs on the panel, Olsen asked: "Why wouldn't you put up – at least at the end of the waterfall – all of your capital?"

Olsen's proposal would force CCPs to use all their operating capital before resorting to measures such as mandatory assessments on clearing members or haircutting the variation margin gains of end-users.

Kevin McLear, corporate risk officer for Ice, dismissed the idea. "As a regulated entity, we need to be concerned about our regulatory capital requirements for all of our clearing houses. We need to maintain a certain amount of operating capital to perform our current function," he said.

We are also asked to contribute to the guarantee fund for risks we didn't introduce

Olsen's comments are part of an increasingly fierce debate over the amount of capital – or 'skin in the game' – CCPs should put at risk. Banks are calling on clearing houses to contribute more capital to align their interests with members, while clearing houses claim their interests are already aligned.

In analysis published in Risk, Citi found the largest European and US clearing houses had a capital-to-default-fund ratio of only 2.6%. Citi argued a rates CCP should have a ratio of 8.1% based on expected shortfall calculations of the amount of tail risk these clearing houses face.

In a white paper published last year, JP Morgan called on CCPs to put up at least 10% of the capital in the default fund or an amount equivalent to the contribution of the single largest clearing member.

The US does not prescribe any standards on CCP skin in the game, so clearing houses can decide for themselves how much capital to put up.

Singapore, meanwhile, requires CCPs to contribute capital equal to 25% of their guarantee funds – a commitment that puts the swaps clearing house operated by the Singapore Exchange "ahead of the curve", according to a director of the exchange.

The European Market Infrastructure Regulation calls on CCPs to put 25% of their capital into the default waterfall – potentially a much smaller amount than in Singapore.

Commenting on the requirements in Europe, David Weisbrod, chief executive of LCH.Clearnet, said: "We think that's a very good approach. We adhere to that in the US voluntarily."

Sunil Cutinho, president of CME Clearing, said the calls for CCPs to stump up more capital ignores the risk-substitution effect of skin in the game.

"If a CCP's contribution into the waterfall were equal to the entity that had the largest constitution, then the very same entity can decrease its risk," Cutinho said. "So in what way is that skin in the game? That is exactly the opposite."