Trade exposures with CCPs - CRR Provision

Regulatory Capital Anatomy™ The JC’s untutored thoughts on how bank capital works. →Go uptown 306(1). An institution shall apply the following treatment to its trade exposures with CCPs: 306(1)(a) it shall apply a risk weight of 2 % to the exposure values of all its trade exposures with QCCPs; 306(1)(b) it shall apply the risk weight used for the Standardised Approach to credit risk as set out in Article 107(2)(b) to all its trade exposures with non-qualifying CCPs; 306(1)(c) where an institution is acting as a financial intermediary between a client and a CCP and the terms of the CCP-related transaction stipulate that the institution is not obligated to reimburse the client for any losses suffered due to changes in the value of that transaction in the event that the CCP defaults, the exposure value of the transaction with the CCP that corresponds to that CCP-related transaction is equal to zero. — Section 306(1), CRR View Template Capital Requirements Regulation: 575/2013/ (EUR Lex) | BIS publications: BIS capital requirements for bank exposures to central counterparties | leverage ratio | RWA | portfolio risk | systemic riskIndex: Click ᐅ to expand: Regulatory Capital Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

In which the Capital Requirements Regulation 575/2013 (EUR Lex)) requires that, for a clearing member to achieve a zero weighting on its exchange traded derivatives clearing business, it must first be able to pass losses occasioned by the default of a CCP on to its client.

The clearing member’s own negligence, fraud or wilful default

But it will be a generous client indeed who does not insist on a carve-out from that right for defaults caused by the clearing member’s own negligence, wilful default or fraud. Would such a carve-out invalidate an application of 306(1)(c)?

Respectfully, it is submitted, it would not:

It is clear in 306(1)(c) that whether or not the CCP is generally “in default” in the abstract, in the sense of being “insolvent” it must have specifically defaulted under the transaction (that is, it must have failed to pay something that it owed to the clearing member).

Of course, a CCP’s insolvency would be likely to lead to a transaction default.

Any negligence, wilful default or fraud on the clearing member’s part under the CCP transaction would, QED, be a default by the clearing member. The CCP then would be entitled to withhold payment under the transaction; ie, it would not be in default in doing so.

What, then, if a clearing member default were so egregious that it caused the total failure of the CCP, meaning the CCP failed to pay even amounts that it was obliged to pay on default by the clearing member?

So a loss to the clearing member which arose out of the CCP’s inability to perform under a transaction which, in turn, came about as a result of the clearing member defaulting to that CCP would not be “loss suffered in the event that CCP defaults”: if the clearing member sued the CCP for that loss, it would fail.

Looking at it another way, if such a carve-out did invalidate 306(1)(c) then the provision would have no application at all, because it would be commercially impossible to remove it.

See also

• The Basel / BIS paper on which this turbulent regulation was based: Capital requirements for bank exposures to central counterparties