Stress testing is a crucial tool within a CCP’s toolbox for ensuring the stability, safety, and resilience of the financial market, says a new paper from CCP12.
Industry body CCP12 has published a new paper on credit stress testing, emphasising its criticality as part of a CCP’s overall risk management approach.
Regular credit stress tests are used by CCPs in their risk management practices to assess the sufficiency of their resources to absorb losses under extreme but plausible market conditions, the paper says.
“If the results of the Stress Tests show, that the losses caused by the potential default of a specific clearing member were to exceed the available collateral, additional collateral may be charged.”
This risk management practice, the paper says, allows CCPs to be better prepared in case of an actual clearing member default, while also serving as an early warning to the clearing member community – in support of the financial market as a whole.
Stress tests have to be performed on a daily basis and the scenarios are reviewed regularly to also take into account the current market conditions.
In the context of the Covid-19 pandemic, CCPs amended their stress testing processes to include scenarios which take into account enhance market volatility, CCP12 says.
The paper sets out regulatory expectations on a CCP’s credit stress testing framework, discusses the different approaches to stress testing, and describes the independent review and validation process.
The full paper is available here.