CCPs

Keeping markets on an even keel: How clearinghouse strength provides resilience

By: John Davidson, Chief Executive Officer, OCC Oct 2020

For most people, the name Lehman Brothers evokes the worst days of the 2008 financial crisis. For OCC and other central counterparty (CCP) clearinghouses, it represents an inflection point that demonstrated how crucial CCPs are in providing operational and financial resiliency for financial markets. Throughout volatile times, including those seen so far this year, centrally cleared markets have continued to deliver stability and market integrity for investors.

OCC has fulfilled its responsibility to market participants every day for nearly 50 years, yet we constantly work to improve our robust risk management framework to ensure our clearance and settlement responsibilities function during regular and extreme markets. In fact, nine of OCC’s top 10 volume days in its history have occurred in the past several months of 2020, averaging more than 28 million contracts daily. And in September, we surpassed the annual cleared contract volume record for the US exchange-listed options industry with over 5.45 billion contracts cleared to date. All the while, more than 98 percent of OCC’s employees worked from home due to the coronavirus pandemic.

OCC’s efforts to fulfil our responsibilities to the market include engaging regularly with market participants. Last year, a group of buy- and sell-side firms released a paper recommending changes to the operating and oversight structures of CCPs. While these recommendations came before CCPs managed the challenges that markets faced during the current pandemic, we value these perspectives and agree with the authors in many instances. Above all, we share an interest in well-functioning markets.

Over the past decade, CCPs like OCC have committed unprecedented resources to delivering the enhanced financial and operational resilience expected by policy-makers, regulators, and market participants. More recently, OCC has embarked on our Renaissance Initiative, a multi-year effort to modernise our technology infrastructure and make our organisation more agile and responsive to the needs of market participants.

Today, OCC remains committed to delivering operational excellence, financial integrity and efficiency to market users. In September, we published a paper titled, “Optimizing Incentives, Resilience and Stability in Central Counterparty Clearing,” that speaks to some of the recommendations made last year regarding a path forward for CCP resiliency. In the paper, we offer our viewpoints to maintain an active and productive dialogue with market participants about steps OCC has taken to build upon our current strength and resiliency.

It is vital for CCPs to have governance practices in place to obtain and address input from a broad array of market participants. Talking through issues on a regular basis and making enhancements where needed is integral to the healthy functioning of any organisation, and the design of our board of directors – comprised of clearing members, exchange representatives and public directors – reflects our prioritisation of that effort. At the same time, we believe it is vitally important for CCP management to have – based on previously agreed upon rules and resources – the authority to make critical and timely decisions, particularly during periods of stress.

When it comes to financial resources, OCC has sized its default fund to a Cover 2 standard, meaning that OCC can cover the possible simultaneous failure of its two largest clearing member firms. To ensure effective risk management, we believe skin-in-the-game, while not a regulatory requirement in the US, and capital allocation to a default fund, are important. Given our unique utility structure, we included in our skin-in-the-game unvested executive deferred compensation – a powerful alignment of interests between OCC management and our clearing members. We are proud of that initiative, and in August announced our intention to take our commitment further and propose to our regulators enhanced, persistent skin-in-the-game at a level consistent with European regulatory requirements.

At the end of the day, market participants and CCPs like OCC have the same goal: a resilient and effective marketplace in regular times and in times of stress. While there is always room for improvement, the success of CCPs during past and present market volatility indicate that the fundamentals of the current financial ecosystem are strong, and we are committed to maintaining that into the future.