EU hands CCP members a narrow win on skin in the game

Clearing members could use the final rules to push for higher CCP capital globally
Tug-of-war montage

  • After almost four years of European Union legislators drafting proposals and then haggling between each other, an agreement has been reached on the regulation dictating the procedures for resolving a central counterparty in crisis.
  • CCPs and their clearing members have often lobbied against each other on various aspects of the rules in a struggle over how much each of them pays. Legislators have carved a careful compromise between each side’s stance.
  • A vaunted win for clearing members has been the increase in the amount of resources CCPs have to put at risk in case of a member default. This would substantially increase the amount of so-called skin in the game (SITG) that LCH, and possibly Ice Clear Europe, put forward.
  • But some clearing members want the law to go further: rather than determining the minimum amount based on regulatory capital requirements, they think it should reflect the total that clearing members contribute to clearing house default funds.
  • European CCPs argue against this, saying nowhere else in the world has two amounts of SITG – but clearing members are already setting their sights beyond Europe.

You win some, you lose some. After an almost four-year battle between central counterparties and their clearing members about who pays when a clearing house fails, European Union legislators have been able to strike a compromise. The result leaves both sides feeling satisfied on some scores, but disappointed on others.

One change clearing members have managed to bag is a provision that will mean European CCPs will have to put more of their own resources on the line. The amount of so-called skin in the game (SITG) clearing houses hold has been a source of contention between the two camps for years. Those who are pleased with the result think it will encourage CCPs to make sure each member’s default fund contributions are sufficient to cover possible losses if the member fails.

“I think it is a clear improvement to incentivise the CCP to sufficiently size the default fund by having this second tranche of skin in the game,” says Ulrich Karl, head of clearing services at the International Swaps and Derivatives Association. “The regulation at a minimum makes sure that the 10% capital buffer that CCPs have to hold anyway is exposed.”

But not all clearing members think this is enough. And, at the moment, the new rules only apply in Europe. Some clearing members are hoping the EU’s new stance will put pressure on other jurisdictions to increase the amount of SITG that clearing houses must hold. That’s a position that has always been disputed by the CCPs themselves.

On June 23, the Council of the EU, European Parliament and European Commission reached a political agreement on procedures for resolving a CCP in crisis, known as the CCP recovery and resolution regulation.


The rules outline the powers and limitations placed on resolution authorities, as well as how much each player could pay to return the CCP to a matched book and avoid it going into a messy bankruptcy.

According to the default waterfall, if the default fund contributions and initial margin posted by a clearing member unable to pay their obligation is short of the outstanding amounts the member owes, CCPs must use some SITG to cover losses before they can pass any further shortfall to non-defaulting clearing members.

I think it is a clear improvement to incentivise the CCP to sufficiently size the default fund by having this second tranche of skin in the game

Ulrich Karl, International Swaps and Derivatives Association

Chipping away

The European Market Infrastructure Regulation (Emir) requires the SITG amount to be 25% of the CCP’s total regulatory capital requirements determined under the regulation by the risks stemming from its activities. Although based on the CCP’s minimum requirements, CCPs must not use the same resources to meet both the SITG and the minimum capital requirements.

Once they’ve burned through that skin in game, CCPs can use other members’ default fund contributions and apply losses to members more broadly through the use of other tools.

Clearing members have long complained CCPs are thinly capitalised and don’t have enough of their own resources on the line. They argue that the more of a CCP’s own resources are on the line, the less likely a CCP is to mismanage risks and go into resolution.

Although CCPs do not take risks themselves, they are responsible for controls to make sure there isn’t a build-up of risk among members that would endanger the clearing house. Clearing members say they have little transparency as to how CCP risk models work and little influence on their settings.

CCPs argue, however, that they don’t create risks in the system and so shouldn’t bear the risk of a member default. A risk expert at a CCP says a running theme in the past few years has been efforts by clearing members to erode the amount of loss mutualisation they are liable for. Increasing the SITG is one front in this campaign.

“Over the years, what has happened at most CCPs is that there has been downward pressure on the amount of mutualisation that the inner ring is providing and, at the same time, there has been increased calls from them for the CCP to have more of its own equity and resources in the waterfall,” says the risk expert at a CCP. “The argument should come with members contributing more as well, and that hasn’t always been consistent in their arguments.”

CCPs also look at other ways to ensure they’re incentivised to display adequate risk management. For example, according to an LCH white paper from 2015, senior managers’ compensation would be hit if the CCP has to dip into its SITG.

Partly covered already

Clearing members’ arguments seem to have cut through with EU legislators, as the new rules will require CCPs to contribute a second SITG amounting to 10–25% of their Emir regulatory capital requirements.

The European Securities and Markets Authority (Esma) has been tasked with drafting a regulatory technical standard (RTS) setting out the methodology to determine the precise amount of the second SITG that clearing houses should hold. The draft must be submitted to the European Commission 12 months after the regulation enters into force. Market participants assume the methodology is likely to reflect the size of the risk handled by each individual CCP.

Some CCPs may have to raise more capital depending on the outcome of the RTS and whether the second SITG requirement is greater than the excess capital they hold on top of their regulatory minimum levels.

Simon Gleeson, Clifford Chance
Simon Gleeson

A CCP should have at least 10% of capital in excess of its regulatory minimum requirements because an early-warning tool – designed to inform authorities of a potentially unstable CCP – outlined within a delegated act of Emir, requires CCPs to notify regulators if their capital levels fall below 110% of their Emir-based capital requirements. Once a CCP’s capital falls below the notification threshold, the CCP has to update their local supervisors weekly on the reasons why their capital is below the notification threshold, along with a description of the CCP’s financial situation in the short term.

The new regulation allows the capital held to meet this 10% notification threshold to be used to meet the second SITG.

This means if Esma sets a CCP’s second SITG amount at 10%, the CCP should not have to raise more capital. But if the amount set by Esma for a CCP is greater than the amount of capital they hold in excess of the notification threshold, then the CCP may have to raise more capital. attempted to work out how much more SITG European CCPs will need to contribute to the default waterfall based on their public disclosures of the amount of SITG they held on March 31 this year. At least one CCP would definitely need to increase its capital on the back of the new regulation, while two others most likely will already hold sufficient capital (see Box: Just how much more?).

All eyes on Esma

The precise amount of minimum second SITG that clearing houses will have to hold will depend on the outcome of the Esma RTS. It is understood legislators forged the compromise explicitly on the basis that they would try to avoid CCPs needing to raise more capital.

“The intention is that a CCP can deploy existing resources if they have conservation buffers under Emir, or other such things to account for those,” says the risk expert at the CCP. “That is one area where the RTS that Esma and the EC will be drafting will make a difference.”

Most CCPs already have more money than they know what to do with and requiring them to raise this stuff in a fully funded form just gives them a negative carry, which impacts their costs

Simon Gleeson, Clifford Chance

One consideration Esma must take into account is the complexity of the CCP’s activities, and the appropriateness of asking a CCP to invest in an additional amount of dedicated own resources. This provision could mean Esma tries to avoid driving up the costs of clearing by forcing CCPs to raise more capital, particularly for smaller CCPs. Since clearing houses have very tight rules on how they can invest surplus cash, they may not be able to generate a sufficient return to cover their cost of capital.

“A massive difference between a bank and a CCP is that a bank always has a use for money,” says Simon Gleeson, a partner at law firm Clifford Chance. “That is not true of CCPs. Most CCPs already have more money than they know what to do with and requiring them to raise this stuff in a fully funded form just gives them a negative carry, which impacts their costs.”

Global leader?

Another consideration Esma must factor in is the ability of EU clearing houses to remain competitive with CCPs in third-countries.

“A mandated second SITG is something that does not exist anywhere else in any other jurisdictions in the world,” says a spokesperson for the secretariat of the European Association of CCP Clearing Houses (Each). “It is a concern because of the competitiveness of EU CCPs and it would also be a concern for the smaller CCPs because for them, they perhaps could not be able to take on this additional SITG.”

No other jurisdiction currently has a second SITG requirement. In the US there are no official rules on this at all, and amounts are determined by CCPs.

But some clearing members intend to use the new EU regulation as the thin end of the wedge, holding up the EU as a “global leader” that they hope other jurisdictions will follow by example.

A risk specialist at one clearing member says they are hoping Esma and the European Commission take the EU requirements for additional SITG levels into account when assessing whether CCPs in other jurisdictions are subject to equivalent regulation. An equivalence decision enables EU clearing members to belong to the third-country CCP and greatly reduces the capital requirements for European banks on trades cleared at these overseas CCPs.

Asking clearing houses to bear more financial risk in the case of a default – beyond what we already contribute – would create a moral hazard

Spokesperson, CME Clearing

“I’m hoping this does help to move the needle more globally on SITG requirements,” says the risk specialist. “When you look at it in practice, the numbers are not really high anywhere.”

Under a revamped version of Emir, which was finalised in October 2019, Esma was given powers to assess the systemic risk of third-country CCPs applying for equivalence. Those it deems to be a systemic risk are classified as tier-two CCPs and must accept direct oversight from Esma.

A recital (introductory paragraph) in the new Emir rules on CCPs states that the presence of a framework for recovery and resolution of CCPs should be taken into account by Esma in its analysis of the degree of systemic risk a third-country CCP poses.

A spokesperson for US-based CME Clearing says that asking CCPs to put more resources on the line than today would create a moral hazard by reducing the incentives for clearing members to manage their own risks properly.

“Clearing houses exist to manage risk – they don’t create it,” says the spokesperson. “Asking clearing houses to bear more financial risk in the case of a default – beyond what we already contribute – would create a moral hazard by reducing the need for each entity to do their own prudent risk management.”

The spokesperson for the Each secretariat says SITG is meant to maintain high standards for resilience at CCPs rather than be a material component of loss absorption. They also state there is no quantitative analysis from public authorities to suggest the current calibration of Europe’s SITG doesn’t fulfil its purpose.

A different denominator

Nonetheless, some clearing members say the new regulation doesn’t go far enough. The risk specialist at the clearing member says CCPs’ remaining capital should be used to cover any outstanding losses at the end of the waterfall after losses have been imposed on clearing members. The CCP would then need to be recapitalised afterwards.

This specialist calls for SITG to be calculated using members’ default fund contributions as the starting point, rather than existing CCP capital. Comparing SITG amounts as a proportion of their members’ default fund contributions shows SITG levels vary between CCPs. But many of the largest have levels below 10%, a target the risk expert at a European investment bank wants CCPs to meet.

“We think 8–10% of the default fund size is an appropriate level,” says the risk expert. “There could be more work being done on what it should be or it could be equivalent to their largest clearing member’s contribution. It shouldn’t be fixed to a separate measure from the default fund, because if the default fund increases because a clearing member’s risk increases, then the skin in game should increase as well.”

A report by the European Systemic Risk Board in 2015 supported this stance, suggesting that SITG should be calibrated based on “the level of the CCP’s clearing activity in order to ensure that these incentives are in some way proportionate to the quantitative dimension of the risks it manages”.

But some CCPs don’t agree SITG levels should be compared through a ratio with their members’ default fund contributions.

One CCP source says expressing SITG this way is akin to comparing apples with oranges. CCP regulatory capital requirements are determined based on it having sufficient resources to facilitate an orderly wind-down and offer adequate protection against the credit, counterparty, market, operational, legal and business risks that the CCP itself is running. The CCP source says this is an appropriate measure to base SITG on rather than member contributions, which are based on how much risk members bring to the system.

The spokesperson for CME Clearing also disagrees with this way of comparing clearing houses’ SITG and says a more appropriate comparison is measuring the CCP contributions relative to each member rather than aggregate member contributions.

For example, CME’s interest rate swap clearing service has an SITG of $150 million, whilst the average individual member contribution is $148.8 million and the median is $72.8 million.

Editing by Philip Alexander

This story originally appeared in Central Banking’s sister publication,

Just how much more?

LCH’s annual report states that on aggregate it contributes the equivalent of 25% of its minimum regulatory capital to its clearing services’ default waterfalls, as is required by Emir. That means the second SITG contained in the CCP recovery and resolution regulation will necessitate extra capital.

According to LCH’s first-quarter public disclosures, SwapClear’s SITG would have to increase from £55.2 million ($72.6 million) to between £77.4 million and £110.5 million.

Meanwhile, it is understood LME already contributes two amounts of SITG and both total 25% of their regulatory capital. The second amount of SITG is used after members’ default fund contributions and alongside additional resources members have to give LME. This means LME already has dedicated resources it can use to cover the maximum possible second SITG, but would have to tweak its rulebook so that the second SITG is used before additional member contributions, rather than in equal proportions.

A spokesperson for Nasdaq Clearing says on aggregate, its first amount of SITG equals 36% of its Emir regulatory capital requirements across all three of its clearing services. Nasdaq also has a second amount of SITG that is shared across its three clearing services. The two together total 59% of Nasdaq’s regulatory capital requirement. That should mean the clearing house already commits enough resources to meet the new requirements, whether or not its shared second SITG has to be apportioned. was unable to determine whether the amounts disclosed by other major European CCPs were 25% of the CCPs’ regulatory capital requirements or more.

Eurex’s website states it contributes “significantly more” than the 25% required in Emir, but doesn’t have an exact figure. A spokesperson for Eurex declined to provide the exact percentage, meaning couldn’t calculate its current SITG. could not find reference to whether the amounts Ice Clear Europe puts at risk are equivalent to 25% of its regulatory capital requirements. A spokesperson for Ice Clear Europe declined to provide the information.

If Ice Clear Europe’s pre-funded SITG is 25% of its regulatory capital requirement, then it would have to increase its pre-funded SITG for credit default swap clearing from €45.3 million ($54 million) to between €63.4 million and €90.6 million.

Ice Clear Europe’s clearing service for futures and options would have to increase its SITG from $183 million to between $256.2 million and $366 million, assuming its current amount of pre-funded SITG is 25% of its regulatory capital requirement.

Ice Clear Europe has another piece of SITG in the form of insurance that is shared by both of its clearing services, and it pays members up to €75 million if their default fund contributions are used. A spokesperson says they treat this as an additional amount of SITG on top of the Emir requirement.

However, two sources say they don’t believe the new rules will allow insurance as an acceptable form of SITG due to the rules stating it must be “pre-funded dedicated own resources”. Insurance isn’t pre-funded – it is only available to pay out to members after the event – nor is it the CCP’s own resources.

Insurance also doesn’t provide the same amount of certainty that it would cover losses as typical dedicated resources such as retained earnings. There is a risk the policy provider won’t pay out due to terms of the insurance, or if the insurer itself collapses.

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