Who owns what in a CCP default

Cheers for this Gary. 

It's important to understand that cash and initial margin assets posted to a clearing house do not stay in the clearing house.  They are deposited in clearing house cash accounts with banks and asset accounts with custodians.  The cash then gets re-used by the bank holding the deposit, as with any deposit.  The securities assets may be subject to lending arrangements by the custodian. 

In the event that a clearing house came under stress and needed its cash and assets back, the clearing banks and custodians would have to raise the cash/assets to return them.  That means liquidity stress on the banks/custodians.  This is a non-trivial source of risk for the CCP in quickly meeting its obligations in the event of a default.

Naturally the CCP will pick very big and safe banks for custody of cash and assets (perhaps even a central bank).  Using commercial banks reinforces the scale bias and liquidity advantage of big banks - and that increasing scale bias reinforces moral hazard and TBTF bias in the system.

We are supposed to be safer once OTC derivatives are margined through CCPs, but the reality is that the security of CCP performance depends on the chain of banks and custodians the CCP relies on.  I don't see the regulation of CCPs addressing this issue yet, but it should be an element in scenario development for stress testing of CCPs by supervisors.  And how we ever counter scale bias created by more complex, global markets and regulation remains a continuing mystery.

Thanks Kathleen, this is a real big worry for the markets but bigger i think for national treasuries and central banks. Do you know if there is any default plans of CCPs to be published and if they plan to test them?

I am looking forward to your presentation and participation in the Post Trade forum debate on these matters and more. I just get the feel that the regulators are creating a ticking bomb and once OTC is in will go atomic