The European Union’s securities watchdog, the European Securities and Markets Authority (ESMA), has called for some clearing houses to bolster their defenses against customer defaults.
This comes after a stress test revealed that UK clearers continue to dominate certain market segments post-Brexit.
Clearers act as intermediaries between buyers and sellers of securities, ensuring trade completion even if one party defaults.
ESMA’s stress test evaluated 16 clearing houses, including those owned by Euronext, Deutsche Boerse, ICE, London Stock Exchange Group, and Cboe.
The test simulated several disruptions, such as multiple user defaults, to assess the clearing houses’ resilience.
“ESMA’s fifth stress test confirmed the overall resilience of the European clearing landscape to severe credit and liquidity stress scenarios,” stated Klaus Loeber, chair of ESMA’s clearing house committee.
However, the test indicated that some clearers need to improve how they handle “concentration” risks.
Market participants with significant positions in specific asset classes face additional margin requirements to cover potential defaults and ensure quick liquidation of positions.
While the additional margin requirements, or “add-ons,” adequately covered stress scenarios for interest rate derivatives, bonds, stocks, and equity derivatives, they were insufficient for commodity and freight derivatives, and emission allowances.
“The gaps were not as large as in past tests but we would like to see continued improvement,” said Froukelien Wendt, ESMA’s director for clearers.
ESMA noted that for many asset classes, a single clearer handles the majority of add-ons, such as LCH for interest rate and forex derivatives.
ICE dominates add-ons for commodity derivatives and emission allowances.
However, no single clearer dominates stocks, equity, and credit derivatives.
In response to the dominance of UK clearers like LCH and ICE, the EU has passed legislation to reduce reliance on them following Brexit.
Permission for LCH and ICE to continue serving EU-based customers directly from London is set to expire in June next year.
The stress test results highlight the challenge of diminishing their dominance over EU rivals swiftly.
Most clearers have begun integrating climate risk from assets like stocks and bonds into their stress testing.
“This exploratory analysis should be understood as a yardstick for further action with regard to climate risks’ monitoring,” ESMA stated.