Investment Operations

ESMA Launches 2021 Central Counterparties Stress Test

EU securities markets regulator ESMA) has published the framework for its fourth Stress Test for Central Counterparties (CCPs). As required by the European Markets Infrastructure Regulation (EMIR), ESMA initiates and coordinates this exercise to assess the resilience and safety of recognised European Union (EU) and Tier 2 Third Country CCPs (TC-CCPs) to adverse market developments and to identify any potential shortcomings.

The 2021 Stress Test addresses credit and concentration risks, and uses improved methodologies, including lessons learned from previous exercises, such as assessing the combination of concentration costs and credit losses when liquidating defaulting portfolios or including an intraday exercise for credit. For the first time, and in line with ESMA’s mandate, ESMA said the exercise also covers operational risk.

“Last year demonstrated that financial systems are constantly evolving and subject to disruptions such as COVID-19 or Brexit,” said Klaus Löber, Chair of the CCP Supervisory Committee. “In that context, it is important to assess that EU CCPs, but also Third Country CCPs of systemic relevance to the EU (so-called Tier 2 CCPs), are resilient as key infrastructures for EU financial stability,” Löber added. “In this respect, the ESMA CCP Stress Test is an essential supervisory tool that contributes to financial stability and supervisory convergence in the EU,” he said.

Scope and components of ESMA’s CCP Stress Test

ESMA, in cooperation with National Competent Authorities (NCAs) and the European Systemic Risk Board (ESRB), tests the resilience of recognised EU and Tier 2 TC-CCPs by exposing them to different stress scenarios comprising extreme but plausible market conditions. The new stress test exercise has the following components:

  • Credit Stress: assessing CCPs’ resources ability to absorb losses under a combination of market price shocks and member default scenarios;
  • Concentration risk: assessing the impact of liquidation costs derived from concentrated positions;
  • Reverse Credit Stress: increasing the number of defaulting entities and level of shocks and/or liquidation costs to identify at which point CPPs’ resources are exhausted; and
  • Operational risk: assessing the importance of shared service providers in the clearing industry and interconnections of CCPs.

Löber said ESMA will also carry out an additional analysis of CCPs’ resources and participants. “In this 4th iteration of the CCP Stress Test, we have further developed the credit and concentration components from the last exercise to develop a more aggregated vision of both risks and introduced a new operational risk analysis with the aim of assessing risks from shared service providers,” he said.

Market Stress Scenarios

According to an ESMA statement, the ESRB General Board approved a new adverse scenario for use in this year’s test. The European Central Bank (ECB), in collaboration with the ESRB and ESMA, developed a new narrative and calibrated the adverse scenario for the CCP Stress Test, involving triggering one or more sources of systemic risk to the EU financial system, as identified by the ESRB.

The CCPs will be exposed to stress shocks that are defined for numerous risk factors across all relevant asset classes, ESMA confirmed, adding that the purpose of the stress test is to assess a CCP’s resilience to macro-economic scenarios that can have a global impact.

The new exercise covers the 13 CCPs authorised in the EU and the 2 UK CCPs classified as Tier 2 (LCH Ltd, ICE Clear Europe Ltd). The publication of the final report and results is scheduled to take place in H2 2022.