Key elements of the 2024 CCP supervisory stress test

Executive summary

The Bank of England’s (Bank’s) 2024 Supervisory Stress Test (SST) of UK Central Counterparties (CCPs) is the Bank’s third public CCP SST exercise. The Bank conducts regular supervisory stress tests of UK CCPs in order to assess their financial resilience, and to promote transparency and confidence in the UK clearing system. While these exercises are not ‘pass-fail’ the findings are used to support and inform the Bank’s supervisory and regulatory activities.

The 2024 CCP SST will focus on two analytical components: the Credit Stress Test and the Credit Reverse Stress Test. In contrast to the Bank’s previous CCP SST exercises, the 2024 CCP SST will not include a Liquidity Stress Test component or analysis of the impact on the UK CCPs’ clearing member population and their clients.

The Credit Stress Test will assess the sufficiency of CCPs’ financial resources to absorb losses under a combination of the Bank’s prescribed market stress scenario(s) and the simultaneous default of selected clearing member groups. The Credit Reverse Stress Test will assess CCPs’ resilience to increasingly severe scenarios and assumptions, in order to identify potential combinations that might deplete CCPs’ prefunded and non-prefunded financial resources.

The Liquidity Stress Test component and analysis of the impact on UK CCPs’ clearing member population and clients will not be included in the 2024 exercise. In combination, the Bank’s previous 2023 CCP SST Liquidity Stress Test, the Bank’s other supervisory reviews in 2024, and the Bank’s ongoing System-wide exploratory scenario (SWES) exercise provide sufficient coverage of CCP’s liquidity risk management over 2023 and 2024. Two UK CCPs are participating in the SWES exercise, which will include an examination of both CCP liquidity risk management and downstream impacts on CCPs’ clearing members and their clients in a market stress.

Both the Credit Stress Test and Reverse Credit Stress Test utilise a bespoke ‘Baseline Market Stress Scenario’, designed by the Bank. This scenario is an extreme but plausible hypothetical scenario, calibrated to a level of severity broadly equivalent to the worst historical shock for each CCP clearing service. It is intended to represent extreme market moves over a period of two to five days in which there is an escalation of geopolitical and trade tensions and downward revision in economic expectations. This results in an increase in commodity prices, and a shift in expectations towards a more rapid decline in interest rates.

Alongside the Baseline Market Stress Scenario, the 2024 CCP SST will include three additional ‘multiplier’ scenarios for the purpose of sensitivity and reverse stress testing. The Bank will also extend the ‘Single Product Reverse Stress Test’ introduced in the previous 2023 CCP SST to explore a wider range of decorrelated market stress scenarios. In contrast to the Baseline and multiplier scenarios, the Bank will use its own independent ‘desk-based’ modelling to undertake the revaluation of clearing member and client positions under these scenarios.

The 2024 CCP SST will use a reference date of end of day Friday 22 March 2024. Market price shocks will apply to market prices and member positions as of end of day on this date, and CCP resources (Initial Margin and Default Fund contributions) will be held fixed as of this date.

The clearing services of 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. CCPs are required to submit the relevant data for the 2024 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 2024 CCP SST results report in 2024 Q4.

Key elements of the 2024 CCP SST

This document sets out the key elements of the Bank’s 2024 Supervisory Stress Test of UK CCPs (the 2024 CCP SST). This covers: (i) participation; (ii) the analytical components of the exercise; (iii) the market stress scenarios; (iv) data submission; and (v) disclosure.

This key element document is complemented by a published spreadsheet containing risk factor shocks for each market stress scenario of the 2024 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’.

Participation

All three UK authorised CCPs – ICEU, LCH and LMEC – will be in scope of the 2024 CCP SST. In total, the 2024 CCP SST will cover six Default Funds and seven clearing services across three CCPs (see Table A).^{footnote [1]} All the clearing services offered by UK CCPs are in scope of the 2024 CCP SST. Temporary recognised non-UK CCPs and recognised non-UK CCPs are not in scope of the exercise.

Analytical components

The 2024 CCP SST will focus on two broad analytical components, the Credit Stress Test and the Credit Reverse Stress Test. These components – detailed further below – will also be complemented by further ‘desk-based’ analysis aimed at testing a wider range of risks, in an extension to the ‘Single Product Reverse Stress Test’ introduced in the 2023 CCP SST.

The Liquidity Stress Test component and analysis of the impact on UK CCPs’ clearing member population and clients will not be included in the 2024 exercise. In combination, the Bank’s previous 2023 CCP SST Liquidity Stress Test, the Bank’s other supervisory reviews in 2024, and the Bank’s ongoing SWES exercise provides sufficient coverage of CCP’s liquidity risk management over 2023 and 2024. Two UK CCPs are participating in the SWES exercise, which will include an examination of both CCP liquidity risk management and downstream impacts on CCPs’ clearing members and their clients in a market stress.

Credit Stress Test

The Credit Stress Test will assess the sufficiency of CCPs’ financial resources to absorb losses under a combination of the Bank’s market stress scenario(s) and the simultaneous default of selected clearing member groups.

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,^{footnote [2]} as well as information provided on account positions (provided for the purpose of concentration cost calculations), and available financial resources (including clearing members’ initial margin, 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.

As a starting point, the Credit Stress Test focuses on the default of the two clearing members whose default results in the greatest depletion of CCP resources (the regulatory ‘Cover-2’ standard). This will include an examination of the additional costs over and above the prescribed market stress scenario(s) that CCPs would face when liquidating defaulters’ concentrated positions (‘concentration costs’). The Bank will also examine a range of alternative defaulter (‘Cover-X’) combinations in order to assess whether resources sized against the Cover-2 standard are sufficient to cover the default of other combinations of Clearing Members.

Credit Reverse Stress Test

As in the Bank’s previous CCP SST exercises, the Credit Reverse Stress Test will assess the impact of increasing the severity of a range of input assumptions on CCP resilience and identify combinations 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 Bank’s previous exercises, 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 (via the use of linear multipliers of the Baseline Market Stress Scenario – see ‘Market stress scenarios’ below).

Market stress scenarios

Each of the Credit Stress Test and Credit Reverse Stress Test components will utilise a bespoke ‘Baseline Market Stress Scenario’, designed by the Bank. The Baseline Market Stress Scenario is intended to represent extreme market moves over a period of two to five days in which there is an escalation of geopolitical and trade tensions and downward revision in economic expectations. This results in a decrease in interest rates prompted by a rapid shift in expectations towards faster cuts in interest rates; an upward shock in commodities prices driven by an escalation in geopolitical tensions and barriers to trade; and a devaluation in the US dollar against other developed market and emerging market currencies driven by political uncertainty and relative changes in government bonds yields. Equity prices increase across the stress-test window, driven by expectations for lower interest rates and the impact of increased commodity prices on commodity producers.

The Baseline Market Stress Scenario is intended to stress different asset classes to a broadly consistent level of severity relative to observed historical market moves, while remaining plausible. Overall, the Baseline Market Stress Scenario contains two-day and five-day shocks to over 900 market prices and rates which 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. The Bank has also carried out an assessment to ensure the scenario is broadly equally plausible at each UK CCP clearing service.^{footnote [3]}

In addition to the Baseline Market Stress Scenario, the 2024 CCP SST includes three further market stress scenarios 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 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 reverse stress testing. The prescribed two-day and five-day shocks for these three additional scenarios are also provided in the ‘2024 CCP SST market stress scenarios’ file.

To complement the scenarios described above, the Bank will also conduct more exploratory ‘desk-based’ analysis to assess CCP resilience to a broader range of theoretical and exploratory market stress scenarios. This will extend the methodology used in the 2023 CCP SST for the Single Product Reverse Stress Test to a wider range of theoretical market stress scenarios in order to test the potential impact of idiosyncratic shocks and emerging risks. This may include, for example, shocks focused on a small subset of products or scenarios that break historically observed patterns of correlation among different risk factors. The impact of these scenarios will be modelled by the Bank utilising CCP data submissions, rather than relying on submitted profit and loss (PNL) estimates.

The 2024 CCP SST will be run on a reference date of the end of day Friday 22 March 2024. This date is selected to be broadly representative of the level of CCP resources and exposures over the period since the Bank concluded its previous CCP SST exercise. Market price shocks will apply to market prices and member positions as of end of day on this date, and CCP resources (Initial Margin and Default Fund contributions) will be held fixed as of this date.

Data submission

Data templates and instructions for both structured and unstructured data have been provided to participating CCPs. 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. Data submitted as part of the 2024 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 2024 Q4. As for the Bank’s previous CCP SST exercises, this document will set out the approach taken in the exercise, analytical results, and the outcomes of the exercise. The Bank has a number of multilateral and bilateral co-operative arrangements with other regulatory authorities for oversight of the CCPs the Bank supervises, and (where appropriate) the Bank may also share relevant information on the key findings of the stress test under the provisions (relating to confidentiality) of such arrangements.