To safeguard the overall integrity of the Clearing House and to protect the mutualizing Default Fund, we conduct an internal credit assessment of all counterparties and perform continuous monitoring of credit, concentration and wrong-way risks. This enables us to guarantee fulfilment of all obligations towards counterparties even under extreme market conditions. Therefore, it is essential for us to monitor all risks arising from the trading portfolios of counterparties on the one hand, and from the collateral deposited to secure such portfolios on the other hand.
From a Clearing House perspective a counterparty is a general term for Clearing Member and segregated Non-Clearing Member/Registered Customer. A counterparty’s portfolio is understood to contain all of its clearing activities such as
The collateral deposited by a counterparty is aggregated in a so-called collateral pool, which contains all instruments in order to fulfil the counterparty’s
As most of the thresholds defined are referring to the notional exposure, we will determine this by taking into consideration both the counterparty’s portfolio and collateral pool. The value of the various product classes is calculated as follows:
In a nutshell, we are dealing with three relevant types of risk:
To map these risks all counterparties, countries and supranational organizations are classified into one of multiple, pre-defined classifications according to a general five-color scheme containing five characteristics - green, yellow, orange, red and not accepted.
Counterparties in a financial transaction face credit risk as an integral part of the overall risk they are exposed to within such business. In general, credit risk is defined as the potential loss one party may suffer if the counterparty fails to fulfil the contractual obligations arising from its transactions. As a central counterparty, Eurex Clearing is of course exposed to credit risk. However since we are a central counterparty to all your trades migrated to Eurex Clearing we also guarantee to fulfil all obligations towards non-defaulting counterparties - even under extreme market conditions. Therefore it is part of our business to monitor all risks arising from the trading portfolios of counterparties on the one hand, and from the collateral deposited to secure such portfolios, on the other hand. In order to comply with our high standards, we conduct an internal credit assessment of all counterparties and guarantee continuous monitoring of credit risks. The assessment is triggered as follows:
Based on these assessments each counterparty will be assigned to one of several pre-defined classifications. We inform all counterparties about their classification and any changes thereof. Furthermore, credit risk thresholds may be set as a control mechanism. The purpose of the thresholds is to reduce the risk of losses as a result of a counterparty’s default. Depending on the particular trading portfolio, credit risk thresholds can be defined either as maximum margin requirement and/or as maximum notional exposure arising from transactions conducted by the counterparty.
The Clearing Member classification also coincides with the applicable concentration and wrong-way risk thresholds for the respective counterparty, explained more in detail in the sections below.
We assume a portfolio or collateral pool to be concentrated if the exposure of a particular position exceeds the aggregated market demand during the anticipated liquidation period. Hereby, market demand depends on market capacity and on the credit quality of the particular security or instrument.
If a counterparty has defaulted, we guarantee a safe and smooth wind-down of the counterparty’s portfolio - with the lowest possible market impact. In order to do so, we collect margin collateral from our counterparties, i.e. we require counterparties to secure the risk exposure arising from their respective portfolios. Additionally, we maintain a mutualizing Default Fund, as well as dedicated own resources to cover additional losses. The adequacy of these financial resources is continuously assessed and monitored.
Generally, margin collateral and contributions to the Default Fund can be made in cash collateral or non-cash collateral, aggregated in the collateral pool. If, as a consequence of a counterparty’s default, we have to liquidate large positions of collateral, such liquidation may cause losses due to a lack of liquidity. Similar losses can arise if the portfolio of the defaulted counterparty is concentrated in certain instruments and we are confronted with a lack in liquidity when winding down the respective portfolio. To avoid such losses, dedicated concentration risk limits are defined, which are applicable to all counterparties. The currently valid concentration risk limts are shown in table 1:
Concentration risk limits which must not be breached
In addition to the counterparty classification, we process so-called country and supranational organization classifications, both of which are considered as input parameters for the definition of concentration risk limits. The classifications follow the same color scheme outlined in the general section, while details about the current classifications can be found in the Eurex Clearing Member Section on our website.
The currently applicable concentration risk limits are shown below. Please note that for these limits both the counterparty’s portfolio and the counterparty’s collateral pool are taken into account.
Concentration risk limits per country classification
For listed fixed income derivatives, the notional concentration limits are not applicable, i.e. the exposures of these instruments are not taken into consideration while assessing the general concentration limits as outlined in the table above. For listed fixed income derivatives, a daily concentration monitoring and early warning system is in place. Clearing Members are proactively contacted in case the share of open interest for an individual instrument exceeds 30%.
Concentration risk limits per supranational organization classification
Another type of risk we are facing in case of a counterparty’s default is the one arising from instruments - which when being liquidated - are likely to decrease in value as they are linked to the credit quality of the counterparty. This kind of risk is referred to as wrong-way risk.
The first step in which we avoid wrong-way risk is that we do not allow counterparties to deposit own issues (or issues of closely linked entities) as collateral. Moreover, counterparties are not entitled to use such instruments as collateral for repo transactions.
In case Clearing Members enter into positions, where they are exposed to the performance of their own stock (e.g. derivatives on their own stock) or other instruments issued by themselves or entities belonging to the same legal group, these positions are collateralized based on the assumption that the underlying becomes worthless in a default scenario. Resources which have already been provided to secure these positions (i.e. dedicated Total Margin Requirement on single position level as well as derived Default Fund contributions) are deducted before the final Supplementary Margin for the own issue positions is calculated. A daily monitoring process ensures a tight control of any own issue position. For a more efficient collateral management process on the Clearing Member side, the Supplementary Margins are charged weekly based on the largest excess (i.e. Loss given default minus already provided resources) over the previous week.
By defining dedicated wrong-way risk limits, we are taking additional steps to minimize such risk. These limits are applicable to a counterparty’s collateral pool and the counterparty’s notional exposure.
In this context, we set limits that consider the home country of the counterparty and the home country of the issuers within the counterparty’s collateral pool and portfolio. Thus, we either refer to "same country" or "any country":
The currently applicable wrong-way risk limits are shown below and are applicable to a counterparty’s collateral pool and the counterparty’s notional exposure. The same handling for listed fixed income derivatives as outlined above for concentration limits applies to wrong-way risk limits.
Wrong-way risk limits for "same country", i.e. the counterparty's home country
Wrong-way risk limits for "any country"