Risk Management Overview
Managing risk is an essential function of ECC, a Central Counterparty (CCP) licensed under the strict European financial market regulations for CCPs (‘EMIR’).
As a CCP, ECC is a legal entity that interposes itself between the counterparties to the contracts traded on one or more markets, becoming the buyer to every seller and the seller to every buyer. Thereby, ECC eliminates the counterparty risk for trading participants on the markets cleared by ECC.
ECC’s risk management rests on three pillars:
First, ECC ensures that General Clearing Members fulfil high standards on financial stability. ECC monitors this on an ongoing basis.
The second pillar is to measure exposures on a near-to-real time basis and requires sufficient collateral from members to cover the potential losses resulting from the close-out of a defaulting member under a variety of market conditions. For Direct Clearing Participants the pre-trade limit implemented in the trading system ensures that all trading exposures are covered.
Third, to cover losses that could exceed collateral in extreme but plausible market conditions, ECC has access to the Default Fund which is a pre-funded contribution by members and an additional contribution by ECC (“Skin in the Game”).
Elements of Counterparty Risk Management
ECC mitigates risks to participants through a system consisting of many elements:
- Novation of trades as soon as they are matched or registered on the different markets. As a result, the trading participant is not exposed to the other trading participants’ credit risk.
- Strict criteria for the admission of Clearing Members: ECC acts on a “principal-to-principal” basis, which means that ECC’s Clearing Members act as intermediaries for their clients’ transactions. With the help of strict admission criteria ECC ensures that its Clearing Members have the necessary resources to fulfil the highest requirements.
- Daily settlement of profits and losses: Open positions are marked to market every day and profits and losses are paid out or collected on a daily basis. Payments are settled on a net basis.
- Margins are required on a daily basis – and, if necessary, intraday in volatile market conditions - to cover current and future exposures of open positions and pending spot market transactions.
- Sharing of residual risk by the Clearing Members, who contribute to ECC’s Default Fund.
ECC constantly reviews and improves its methods and risk tools to provide state-of-the-art risk management. In the development of its margin system ECC cooperates closely with Partner Exchanges, Clearing Members and the financial supervisory authority.
Operational and Investment Risk
ECC strives to reduce manual intervention in the clearing process thus achieving Straight-Through Processing which reduces the risk of manual errors.
For critical processes ECC operates two geo-redundant IT operation centres that are both linked to ECC’s main office and its backup office. Backup procedures are defined for all critical processes. These backup processes are tested on a regular basis.
For payments ECC uses central bank money for all Euro payments. ECC is a designated payment system according to Article 10 of the Settlement Finality Directive 98/26/EC.
Cash margins received are only invested in assets with minimum market risk at counterparties with minimum counterparty risk.