Key elements of the 2023 CCP supervisory stress test

1: Executive summary

The Bank of England’s (Bank’s) 2023 Supervisory Stress Test (SST) of UK Central Counterparties (CCPs) is the Bank’s second public CCP SST exercise. Consistent with the previous exercise, the 2023 CCP SST will explore the individual and system-wide credit and liquidity resilience of UK CCPs, and their interconnectedness with the rest of the financial system. The exercise aims to identify any potential vulnerabilities and gaps in CCPs’ resilience, and will be used to support and inform the Bank’s supervisory and regulatory activities.

All three UK authorised CCPs (ICE Clear Europe Limited (ICEU), LCH Limited (LCH), and LME Clear Limited (LMEC)) will be in scope of the exercise.

As in the previous exercise, the 2023 CCP SST will include a Credit Stress Test, a Credit Reverse Stress Test, a Liquidity Stress Test, and a Clearing Member and Client Analysis. The Credit Stress Test will assess the sufficiency of CCPs’ resources to absorb losses under a combination of the Bank’s market stress scenario(s) and the simultaneous default of selected clearing member groups. The Credit Reverse Stress Test will assess the severity of a range of input assumptions required to deplete CCPs’ prefunded and non-prefunded financial resources. The Liquidity Stress Test will assess CCPs’ liquidity resilience under a combination of the Bank’s ‘Baseline Market Stress Scenario’ and the simultaneous default of selected clearing member groups. The Clearing Member and Client Analysis will examine the impacts of the 2023 CCP SST from the perspective of the UK CCPs’ clearing member population and their clients. Where appropriate, the Bank may restructure the presentation of this analysis and/or introduce additional analytical components in the 2023 CCP SST results report.

Each of these components will utilise a bespoke Baseline Market Stress Scenario, designed by the Bank. This is not a forecast, but a hypothetical scenario. It involves a global economic downturn scenario combined with a significant supply-side shock on commodities. It consists of a rapid increase in the prices of metals, oil and energy derivatives; a sell-off in equity markets; increases in swap rates and government bond yields; and a depreciation of most advanced and emerging-market currencies against the US dollar. Overall, this scenario is calibrated to a level of severity broadly equivalent to the worst historical shock for each CCP clearing service in scope,^{footnote [1]} and is applied on a reference date of end of day Friday 10 February 2023.

In addition to the Baseline Market Stress Scenario, the 2023 CCP SST will include three additional market stress scenarios which will predominantly be utilised for the purpose of sensitivity testing, reverse stress testing, and exploratory analysis. Each of these scenarios is constructed by applying linear multipliers (of -1.0x, 1.5x and 2.0x respectively) to the individual risk factor shocks in the Baseline Market Stress Scenario.

CCPs are required to submit the relevant data for the 2023 CCP SST to the Bank using data templates and instructions provided privately to them. The Bank will then undertake the relevant results analysis and intends to publish the 2023 CCP SST results report in 2023 Q4.

2: Background and objectives

This document sets out the key elements of the Bank’s 2023 Supervisory Stress Test of UK Central Counterparties (the 2023 CCP SST). The 2023 CCP SST is the Bank’s second public CCP supervisory stress test and follows the publication of the Bank’s 2021–22 CCP SST results report in October 2022.

CCPs lie at the heart of the financial system, playing a crucial role in the functioning of financial markets. CCPs enable the clearing of financial transactions, acting to guarantee that a transaction will be honoured if a party defaults on a trade. The Bank supervises CCPs because of their importance to the smooth functioning of the financial system and wider economy.

The 2023 CCP SST is consistent with the Bank’s intention to conduct regular supervisory stress testing of CCPs as part of its ongoing supervision and regulation of financial market infrastructures. As for the 2021–22 CCP SST, the 2023 CCP SST will explore the individual and system-wide credit and liquidity resilience of the CCPs in scope, and their interconnectedness with the rest of the financial system. The exercise will aim to identify any potential vulnerabilities and gaps in CCP resilience, and the findings will be used to support and inform the Bank’s supervisory and regulatory activities.

Section 3 of this document sets out the key elements of the 2023 CCP SST exercise. This covers: (i) participation; (ii) the analytical components of the exercise (including details of the applicable methodology); (iii) the market stress scenarios; (iv) data collection; and (v) disclosure.

This key elements document is complemented by a published XLSX file containing risk factor shocks for each market stress scenario of the 2023 CCP SST. Participating CCPs have also been privately provided with ‘Instructions for completing the structured data templates’, ‘Structured data templates’, a ‘Supplementary data request’, and ‘BEEDs data submission instructions’.

3: Key elements of the 2023 CCP SST

Participation

All three UK authorised CCPs – ICEU, LCH and LMEC – will be in scope of the 2023 CCP SST. In total, the 2023 CCP SST will cover six Default Funds and seven clearing services across three CCPs (see Table A). All of the clearing services offered by UK CCPs are in scope of the 2023 CCP SST, with the exception of ICEU CDS.^{footnote [2]} Temporary recognised non-UK CCPs and recognised non-UK CCPs are not in scope of the exercise.

Analytical components

The analytical components of the 2023 CCP SST remain broadly unchanged from the 2021–22 CCP SST, with modifications and enhancements implemented where appropriate. Overall, the Bank intends to include four overarching analytical components in the 2023 CCP SST. This includes a Credit Stress Test, a Credit Reverse Stress Test, a Liquidity Stress Test, and a Clearing Member and Client Analysis (each of which are explained in further detail below). The Bank reserves the option to restructure the presentation of the 2023 CCP SST analysis and/or introduce additional analytical components using the collected CCP data where appropriate.

Credit Stress Test

The Credit Stress Test component of the 2023 CCP SST will assess the sufficiency of CCPs’ resources to absorb losses under a combination of the Bank’s market stress scenario(s) and the simultaneous default of selected clearing member groups. As part of the Credit Stress Test, the 2023 CCP SST will also include an examination of the additional costs over and above the prescribed market stress scenario(s) that CCPs would face when liquidating concentrated positions of defaulters (‘concentration costs’).

To run the Credit Stress Test, the Bank will utilise information provided by CCPs on the profit and losses resulting from impact of the Bank’s market stress scenario(s) at each account, as well as information provided on account positions (provided for the purpose of concentration cost calculations), and available financial resources (including clearing members’ margins, mutualised default fund contributions and additional resources).

Using this information, the Bank will analyse the impact of its market stress scenarios and the simultaneous default of selected clearing member groups on clearing member resources and CCP default funds. The choice and application of defaulters will be performed by the Bank using information provided by CCPs. Where clearing members default, all clearing members (legal entities) incorporated within the same group are also assumed to be declared in default by CCPs. In addition to analysing the default of the pair of clearing members whose default results in the greatest depletion of CCP resources (for individual Default Funds and across all CCPs in aggregate), the Bank will also examine a range of alternative defaulter (‘Cover-X’) combinations.

The Bank will apply its own assumptions regarding CCPs’ ability to port the client accounts of defaulting clearing members to non-defaulting clearing members. The Bank will also employ its in-house methodology to conservatively estimate the concentration costs that might arise for any given market stress scenario, combination of defaulters and other relevant input assumptions (eg porting assumptions).

Credit Reverse Stress Test

The Credit Reverse Stress Test will assess the impact of increasing the severity of a range of input assumptions on CCP resilience, and test combination of assumptions that are required to deplete CCPs’ prefunded and non-prefunded financial resources.

The Credit Reverse Stress Test will be undertaken as an extension of the methodology in the Credit Stress Test. As in the 2021–22 CCP SST, the Credit Reverse Stress Test will examine increases in the number of defaulting clearing member groups (at a Default Fund and system-wide level), an increase in the severity/conservativeness of the assumptions used to estimate concentration costs, and increases in the severity of market stress shocks (including through the use of linear multipliers of the Baseline Market Stress Scenario – see ‘Market stress scenarios’ below).

As an extension to the 2021–22 CCP SST exercise, the Credit Reverse Stress Test will also be undertaken over all porting assumptions (adding a fourth dimension to the Credit Reverse Stress Test).

Liquidity Stress Test

The Liquidity Stress Test component of the 2023 CCP SST will assess CCPs’ liquidity resilience under a combination of the Bank’s Baseline Market Stress Scenario and the simultaneous default and non-performance of selected clearing member groups. The Liquidity Stress Test will also include an examination of the provision of key services that CCPs rely on for liquidity risk management.

To run the Liquidity Stress Test, the Bank will utilise information provided by CCPs on payment obligations resulting from the Bank’s Baseline Market Stress Scenario for each day in the stress-test window (provided at account level), and data on CCP liquidity resources covering detailed information on non-cash collateral (including where held with a custodian), the investment of cash collateral (including with investment counterparties, agents and custodians of purchased/reverse repo securities), and cash available from the utilisation of committed liquidity facilities. In contrast to the 2021–22 CCP SST Liquidity Stress Test component, CCPs will only be required to provide this information for the Bank’s Baseline Market Stress Scenario, and not for the full set of market stress scenarios (see ‘Market stress scenarios’ below). This is intended to limit the resource demands on CCPs ahead of their engagement with the Bank’s system-wide exploratory scenario.^{footnote [3]}

Using this information, the Bank will approximate payment obligations at the clearing member group level, accounting for clients’ positions under different porting scenarios. The Bank will also calculate liquidity resources available under a range of assumptions relating to the ability of CCPs to mobilise liquid resources.

The choice and application of defaulting clearing member groups will be performed by the Bank using information provided by CCPs, with a focus on the pair of clearing member groups whose default produces the lowest liquidity balance. Where clearing members default, all clearing members (legal entities) incorporated within the same group are also assumed to be declared in default by CCPs. Furthermore, any service providers incorporated within the group will also be assumed to be non-performing for the duration of the stress-test horizon. Under these default scenarios, the Bank will compare the liquid resources that CCPs can mobilise to the liquidity requirements they are exposed to. Using this, the Bank will calculate the net surplus or deficit of liquidity on each day of the stress-test window on a cumulative basis.

Clearing Member and Client Analysis

The Clearing Member and Client Analysis will examine the impacts of the 2023 CCP SST from the perspective of the UK CCPs’ clearing member population and their clients. This component will be undertaken utilising information collected and calculated for the purposes of the Credit Stress Test and Liquidity Stress Test.

As in the 2021–22 CCP SST, this component will include both an analysis of the potential knock-on impacts on the clearing member population resulting from the default of other clearing members, as well as an analysis of the potential liquidity demands on clearing members ad clients. Relative to the 2021–22 CCP SST, the 2023 CCP SST will also include an examination of the Initial Margin calls on clearing member and client accounts resulting from the 2023 CCP SST Baseline Market Stress Scenario.

Market stress scenarios

Each of the analytical components above will utilise a bespoke ‘Baseline Market Stress Scenario’, designed by the Bank. This is not a forecast, but a hypothetical scenario. It involves a significant negative supply-side shock on commodities, combined with a global economic downturn and serious uncertainty over the economic outlook. As such, the Baseline Market Stress Scenario incorporates a rapid increase in the prices of metals, oil and energy derivatives; a sell-off in equity markets; increases in swap rates and government bond yields due to the combination of economic uncertainty and increasing central bank reference rates; and a depreciation of most advanced and emerging-market currencies against the US dollar.

The Baseline Market Stress Scenario is intended to stress different asset classes to a broadly consistent level of severity with regard to observed historical market moves. Overall, the market stress shocks in the scenario are calibrated such that in combination, and with reference to the volumes of products cleared at each UK CCP clearing service, the scenario is broadly equivalent in severity to the worst historical stress experienced for each UK CCP clearing service over the applicable margin period of risk. In designing the Baseline Market Stress Scenario, the direction and relationship between market shocks was grounded in historically observed shocks aligned to the overall scenario narrative as far as possible. However, the Baseline Market Stress Scenario does not replicate any individual historically observed scenarios or shocks.

In total, the Baseline Market Stress Scenario includes two-day and five-day shocks for over 850 market prices and rates (see ‘2023 CCP SST market stress scenarios’). The number of risk factor shocks prescribed by the Bank has increased significantly relative to the 119 individual risk factor shocks prescribed in the 2021–22 CCP SST. This is intended to reduce the amount of scenario expansion that CCPs must undertake to extrapolate the prescribed risk factor shocks to all products and exposures within their respective clearing businesses. In turn, this will ensure greater consistency in the application of shocks between CCPs on the same or similar products. The Bank will keep the balance between the provision and extrapolation of risk factor shocks under review for future CCP SST exercises.

In addition to the Baseline Market Stress Scenario, the 2023 CCP SST will include three additional market stress scenarios which will be predominantly utilised for the purpose of sensitivity testing, reverse stress testing, and exploratory analysis. Each of these scenarios are constructed by applying linear multipliers to the individual risk factor shocks in the Baseline Market Stress Scenario. The first additional market stress scenario represents an exploratory ‘opposite direction stress scenario’, in which all risk factor shocks in the Baseline Market Stress Scenario are multiplied by -1.0x.^{footnote [4]} This scenario is intended to allow for relatively simple exploratory analysis of a wider range of market stress shocks, without the requirements to build and extrapolate a bespoke market stress scenario. The second and third additional market stress scenarios are generated using 1.5x and 2.0x multipliers of the shocks in the Baseline Market Stress Scenario, respectively, and are intended to be used for the purpose of sensitivity analysis and reverse stress testing. The prescribed two-day and five-day shocks for these three additional scenarios are also provided in the ‘2023 CCP SST market stress scenarios’ XLSX file.

For the 2023 CCP SST exercise, the reference date is Friday 10 February 2023. As such, each of the Baseline Market Stress Scenario and additional market stress scenarios apply to market prices and member positions as at end of day on this date.

Data submission

Data templates and instructions for both structured and unstructured data have been provided to participating CCPs privately. As part of the submissions process, CCPs are required to put in place processes to ensure high-quality data prior to submission to the Bank (including oversight by a person of appropriate seniority eg Chief Risk Officer).

Once CCPs have provided final submissions, the Bank will run further validations and plausibility checks. Once the data quality checks are finalised, the Bank will run the stress test analysis. CCPs should note data submitted as part of the 2023 CCP SST may also be used for other supervisory and financial stability purposes.

Disclosure

The Bank intends to publish the results and findings from the stress-test exercise in a results report in 2023 Q4. As for the 2021–22 CCP SST, this document will set out the approach taken in the SST exercise, analytical results, and the outcomes of the exercise. The Bank has a number of multilateral and bilateral co-operative arrangements for oversight of the CCPs it supervises, and (where appropriate) may also share relevant information on the key findings of the stress test under the provisions (relating to confidentiality) of such arrangements.