EVALUATION OF CLEARINGHOUSE LIQUIDITY

A REPORT BY STAFF OF THE U.S. COMMODITY FUTURES

TRADING COMMISSION 

OCTOBER 2017 

DISCLAIMER 

This is a report by staff of the U.S. Commodity Futures Trading Commission. Any 

views expressed in this report are solely the views of staff, and do not necessarily 

represent the position or views of any Commissioner or the Commission. 

Table of Contents

Executive Summary.......................................................................................................... 1

A. Nature and Purpose of the Exercise .................................................................. 1

B. Scope of the Exercise ........................................................................................ 1

C. Key Findings...................................................................................................... 2

I. Background................................................................................................................... 3

A. Daily Settlement of Cleared Products................................................................ 3

B. Role of Liquidity Risk Management in the Clearing System ................................ 6

II. Methodology ............................................................................................................... 6

A. Products........................................................................................................... 6

B. Clearinghouses ................................................................................................. 7

C. Stress Scenarios................................................................................................ 8

D. Calculation of Losses....................................................................................... 10

E. Review of Clearinghouse Liquidity Procedures................................................. 12

III. Results...................................................................................................................... 13

A. Use of Non-public Information........................................................................ 13

B. Size of the Liquidity Demand........................................................................... 13

C. Clearinghouse Methods for Generating Liquidity............................................. 14

D. Summary of Methods Used by Clearinghouses................................................ 16

E. Effects across Clearinghouses.......................................................................... 17

IV. Conclusions............................................................................................................... 19

V. Next Steps ................................................................................................................. 19

List of Exhibits

Exhibit 1: DCO Variation Margin Timelines 

Exhibit 2: Total Initial Margin Requirements at all DCOs 

Exhibit 3: Total Futures and IRS Initial Margin Requirements 

Exhibit 4: Comparison of Two Alternative IRS Stress Test Scenarios 

Exhibit 5: Daily Variation Margin in 2016 

Exhibit 6: Sources of Liquidity in the Exercise 
List of Acronyms and Defined Terms 

 2016 Report – Supervisory Stress Test of Clearinghouses 

 AUD - Australian Dollar 

 CAD - Canadian Dollar 

 BPS – Basis points 

 CFTC - Commodity Futures Trading Commission 

 CME – Chicago Mercantile Exchange, Inc. 

 CZK - Czech Koruna 

 DCO - Derivatives Clearing Organization 

 DVP - Delivery Versus Payment 

 EUR – Euro 

 FCM – Futures Commission Merchant 

 FX - Foreign Exchange 

 GBP - British Pound 

 HKD - Hong Kong Dollar 

 HUF - Hungarian Forint 

 ICEU – ICE Clear Europe 

 ICUS - ICE Clear U.S. Inc. 

 IM – Initial Margin 

 IRS - Interest Rate Swaps 

 JPY - Japanese Yen 

 LCH - LCH Ltd 

 LIBOR – London Interbank Offered Rate 

 LSOC - Legally Segregated Operationally Commingled 

 MXN - Mexican Peso 

 NOK - Norwegian Krone 

 NZD - New Zealand 

 PLN - Polish Zloty 

 SEK - Swedish Krona 

 SGD -Singapore Dollar 

 SIDCO - Systemically Important Derivatives Clearing Organization 

 Staff – Staff of Division of Clearing and Risk, CFTC 

 USD - US Dollar 

 VM – Variation Margin 

 ZAR – South African Rand
1

Executive Summary

A. Nature and Purpose of the Exercise

This is the second in a series of systemic stress test exercises conducted by staff of the 

Division of Clearing and Risk (“staff”) of the Commodity Futures Trading Commission 

(CFTC). In November 2016, staff published a report “Supervisory Stress Test of 

Clearinghouses” (2016 Report). The purpose of the 2016 exercise was to assess the 

impact of a set of stressed market conditions and defaults across multiple 

clearinghouses, with a focus on firms that held memberships at more than one 

clearinghouse. The stressed conditions involved hypothetical extreme but plausible 

scenarios. The “Next Steps” section of the 2016 report discussed plans to incorporate a 

number of enhancements and to conduct exercises of this nature on a regular basis. 

Staff has now completed an exercise that addresses a subset of the enhancements listed 

in the 2016 Report. The purposes of the current exercise were to evaluate (i) whether 

clearinghouses could obtain in a timely manner the funds necessary to meet the 

settlement obligations resulting from the simultaneous default of two large clearing 

members and (ii) whether the need for multiple clearinghouses to generate liquidity 

simultaneously might have systemic implications. 

Thus, the focus of this exercise was to evaluate funding liquidity, that is, the ability of a 

clearinghouse to access sufficient cash in the applicable currency to meet its daily 

settlement obligations within the timeframes set forth in its settlement cycle. The 

exercise did not address the liquidity of the underlying derivatives markets, that is, the 

ability of a clearinghouse to hedge and to liquidate the positions of a defaulting clearing 

member. Nor did the exercise address operational risk, or cybersecurity risk. As 

described in the “Next Steps” section of this report, these topics will be addressed in 

future exercises. 

B. Scope of the Exercise 

Staff analyzed the positions of all common clearing members at three clearinghouses 

registered as derivatives clearing organizations (DCOs) with the CFTC: Chicago 

Mercantile Exchange, Inc. (CME), ICE Clear US, Inc. (ICUS), and LCH Ltd (LCH). The 

exercise encompassed futures and options on futures cleared at CME and ICUS, and 

interest rate swaps (IRS) cleared at LCH and CME. 
2

The default scenario assumed the simultaneous failure of the same two large clearing 

member firms and, as applicable, their five largest IRS customers, at each of the three 

DCOs. The hypothetical scenario created almost three times as much liquidity demand 

as would have been created if the two largest firms had defaulted following Brexit. 

C. Key Findings 

All of the clearinghouses demonstrated the ability to generate sufficient liquidity to 

fulfill settlement obligations during the immediate end-of-day cycle, and in the case of 

those clearing IRS, during subsequent payment cycles. 

The clearinghouses generated funds in a number of ways. The range of methods 

included: (i) using cash received from maturing reverse-repurchase agreements, (ii) 

selling collateral, (iii) accessing cash balances at a commercial bank, (iv) accessing cash 

balances at a central bank, (v) converting one currency to another, and (vi) entering into 

repurchase agreements. The three clearinghouses used different combinations of these 

methods. 

In instances where multiple DCOs used the same methodology or the same firm to raise 

funds, staff concluded that the cumulative size of liquidity requirements in this scenario 

would not impair the ability of each clearinghouse to meet its settlement obligations on 

time. 
3

I. Background 

A. Daily Settlement of Cleared Products 

One of the most effective risk mitigating techniques in the clearing system for 

derivatives transactions is the daily settlement process. New trades and open positions 

are marked to current market prices and gains and losses are settled in cash at least 

once a day. At most derivatives clearinghouses, there is an additional intra-day cycle as 

well. 

This mark-to-market process is a very rigorous form of risk mitigation. It ensures that 

losses are not allowed to accumulate for more than a single day. In fact, for 

clearinghouses conducting intra-day settlements, the usual exposure will be for less 

than one day. 

This process, however, can create large liquidity demands in the event of a clearing 

member default. If a clearing member fails to meet its settlement obligations to a 

clearinghouse, the clearinghouse is still obligated to settle in cash to clearing members 

on the opposite side of the market in accordance with the established settlement cycle. 

The initial margin and guaranty fund deposits of the defaulting clearing member might 

be large enough to cover all losses, but they won’t typically be all cash given that 

clearinghouse rules permit clearing members to post a variety of non-cash assets as 

collateral. Therefore, clearinghouses, by design, have arrangements in place to assure 

that sufficient cash is available to meet their settlement obligations. 

The liquidity needs for DCOs clearing futures products are primarily in U.S. Dollars (USD) 

with some exceptions for futures contracts settled in foreign currencies. The liquidity 

needs for DCOs clearing IRS involve multiple currencies, including USD, Euros (EUR), and 

14 other currencies. 

End-of-day settlement cycles include the full range of settlement activities. These 

include the mark-to-market of all contracts and currencies and the payment and receipt 

of 100% of variation margin. 

Intra-day settlement cycles often differ from end-of-day cycles. Examples of the 

differences include: 

 Intraday cycles may not include all products settling in foreign currencies 

 Intraday cycles may collect losses but not pay out gains

 Intraday cycles may collect all losses but pay out less than all gains. 
4

The DCOs in this report that clear futures and options on futures run settlement cycles 

both intra-day and end-of-day. However, they also have rules allowing for flexibility in 

intra-day processing which can mitigate potential intra-day liquidity concerns. For 

example, as noted, a clearinghouse might choose to pay out less than all gains intra-day. 

The clearinghouses have rules in place, publicly disclosed, that allow for this kind of 

flexibility if temporarily needed to address intra-day liquidity. 

The DCOs in this report that clear IRS pay out gains only once a day, at the end-of-day 

settlement cycle. They may collect losses one or more times intra-day. Consequently, 

for the IRS products, in the event of a default the DCOs only have liquidity needs once 

per day. Payment obligations for the currencies that generally account for the majority 

of variation margin are due at the end-of-day settlement cycle. The variation margin for 

the smaller, less-traded currencies is paid the following day. 

The settlement cycle for the three DCOs covered by this report is set forth below in 

Exhibit 1. 
5
6

B. Role of Liquidity Risk Management in the Clearing System

For purposes of this report, the term liquidity refers to the ability of a clearinghouse to 

access enough cash in the applicable currency to meet its settlement obligations within 

the timeframes set forth in its settlement cycle. The term does not refer to the ability to 

liquidate cleared positions. 

The CFTC has issued an extensive set of regulations applicable to clearinghouses related 

to liquidity risk management including requirements addressing liquidity resources, 

liquidity risk management procedures, liquidity stress testing, and reporting 

requirements.1

 

Broadly stated, all DCOs must effectively measure, monitor, and manage their liquidity 

risks, and maintain sufficient liquid resources so they are able, at a minimum, to fulfill 

their cash obligations when due. Moreover, all DCOs must ensure that their liquidity 

resources are held in a manner where the risk of loss or of delay in its access to them is 

minimized. This includes the risk of loss from converting non-cash collateral into cash 

and the risk of delay in accessing cash. 

The purpose of this exercise was not, however, to test whether each individual 

clearinghouse had the liquidity required by the regulations but rather to evaluate the 

impact of an extreme event on liquidity resources across clearinghouses. Given the 

differences among these clearinghouses in membership and in portfolio composition, 

testing clearinghouses individually would likely involve a different default scenario at 

each one. This study used a single scenario involving default across a specific group of 

clearinghouses. 

II. Methodology 

A. Products

Currently, futures and options account for 44% of initial margin (IM) collected by DCOs. 

IRS accounts for 45%. The distribution of IM among products is summarized below in 

Exhibit 2. 

 

1

 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (November 8, 

2011); Derivatives Clearing Organizations and International Standards, 78 FR 72476 (December 2, 2013). 

In particular, see CFTC regulations 39.11(e), 39.33(c), and 39.36(c). 
7

Exhibit 2: Total Initial Margin Requirements at all DCOs, August 16, 2017

In conducting daily risk surveillance of DCOs, staff has observed that, consistent with the 

distribution of IM by asset class, all futures combined and IRS generate almost 90% of 

the daily settlement obligations at the largest clearing members. Accordingly, staff 

determined to limit this exercise to DCOs clearing these products.2

B. Clearinghouses 

Currently, CME and ICUS hold approximately 73% of IM for futures and options at 

registered DCOs; LCH and CME hold approximately 97% of IM for IRS. These numbers 

are summarized below in Exhibit 3. 

 

2

 Futures and options products included the following asset classes: interest rates, equities, energy, 

metals, agricultural, softs, and foreign currencies. 
8

Exhibit 3: Total Initial Margin Requirements on August 16, 2017

In Scope and Out of Scope 

In planning this review, staff determined that in order to have an adequate test of 

systemic DCO liquidity, at least three DCOs would need to be included. Once the asset 

classes were selected, staff selected DCOs that had large clearing members in each of 

the two asset classes. Accordingly, staff determined to limit this exercise to CME, ICUS, 

and LCH. 

C. Stress Scenarios 

Testing the sufficiency of liquidity at a single DCO involves somewhat different 

considerations than testing the potential systemic impact of defaults at multiple DCOs. 

The scenario that causes the largest cumulative losses across DCOs is likely to differ 

from the scenarios that cause the largest loss at each individual DCO. 

Moreover, in order to make legitimate comparisons among clearinghouses, it is 

important that the severity of the liquidity stress be similar at each clearinghouse. 

Therefore, staff needed to identify a price scenario and a pair of defaulting firms that 

would result in a stress loss that was not only extremely large overall but that was also 

proportionately stressful at each DCO. 

Staff notes that this exercise measures the DCOs’ liquidity resources and operational 

capabilities against standards that, in some respects, exceed those required by CFTC 
9

regulations. Accordingly, this review should not be interpreted as a standard setting 

exercise. 

Because the cleared IRS market is now larger than the futures markets, as measured by 

initial margin, staff started the analysis with IRS. Staff initially ran 179 stress test 

scenarios on the interest rate swap portfolios of all clearing members at both CME and 

LCH in order to identify the scenarios that generated the largest losses. These scenarios 

included both historical and hypothetical market movements. Positions as of close-ofbusiness on August 16, 2017 were used for this exercise. 

The goal was to identify the single scenario and pair of firms that best fit the following 

criteria. The losses had to be (i) very large in both asset classes, (ii) very large at all 

three clearinghouses, and (iii) proportionate to the relative sizes of the clearinghouses. 

Staff then followed an iterative process to reduce the number of firms and scenarios 

under consideration. After reducing the number of potential scenarios to four and the 

number of potential clearing members to five, staff added futures stress test scenarios. 

In each case, the price movements in the futures scenarios were consistent with the 

price movements in the IRS scenarios to which they were added. 

For IRS, staff eventually selected a hypothetical “bear-flattener” scenario. This is a 

situation where short term interest rates are increasing faster than long term interest 

rates, thus causing the yield curve to flatten. The specific scenario included upward 

shifts in the USD, LIBOR (London Interbank Offered Rate) curve of 70 basis points (bps) 

for maturities of 5 years and less, 65 bps for the middle tenors, and 60 bps at the far end 

of the curve. 

For comparison, staff identified the largest five-day historical increase in IRS rates in the 

one to five-year tenor points using the past 20 years of data. (See Exhibit 4 below.) This 

historical scenario is one that was also considered, but the hypothetical scenario 

ultimately used resulted in greater liquidity needs. 
10

Exhibit 4: Comparison of Two Alternative IRS Stress Test Scenarios 

Corresponding one-day price moves were applied to interest rate futures. For other 

futures products, staff applied the same extreme price changes that were used in the 

applicable scenario from the 2016 exercise. For example, the S&P 500 was stressed up 

15 percent. The largest daily increase in S&P 500 futures in the past 20 years was 14 

percent. 

The products included in this test settled in 16 different currencies. The currencies 

included: USD, EUR, GBP, CAD, AUD, JPY, CZK, HKD, HUF, MXN, NOK, NZD, PLN, SEK, 

SGD and ZAR. (See List of Acronyms for currency names). 

D. Calculation of Losses

Staff calculated losses in a manner consistent with the treatment of accounts under 

CFTC regulations.3 For house accounts, gains and losses of affiliates were netted. For 

futures customer accounts, gains and losses across all accounts per futures commission 

merchant (FCM) were netted. For swap customer accounts, which are subject to LSOC 

requirements (legally segregated operationally commingled)4, staff calculated the sum 

 

3

See CFTC regulation 1.3(y). 

4

 See CFTC regulations 22.1 - 22.17. 
11

of the five largest individual customer losses at each defaulting firm. This is an extreme 

approach because it assumes that the five largest swap customers would default 

simultaneously. This has not occurred in the past and goes beyond what is required in 

the Commission’s liquidity regulations. 

Futures losses were all applied on Day 1. IRS losses were allocated over the five day 

margin period of risk as follows: Day 1 – 50%, Day 2 – 20%, Day 3 – 10%, Day 4 – 10% 

and Day 5 – 10%. This allocation is generally consistent with the principle that 

cumulative losses are proportional to the square root of time, except that it is slightly 

more front-loaded. 

In calculating these losses, staff made two additional assumptions. Each of these 

assumptions was very conservative. 

The first assumption is that there would be no hedging of the IRS positions in house 

account defaults. Thus, as noted, the stress test losses for Day 1 were assumed to be 

50%, and Days 2 through 5 were assumed to be 50% of total stress test losses. 

For comparison purposes, staff asked the DCOs that clear IRS to estimate the total costs 

if these portfolios had been hedged in this scenario. One DCO provided an estimate 

that the aggregate stress test loss of the hedged portfolio would be 45% lower than the 

unhedged portfolio. The other DCO indicated that the aggregate stress test loss would 

have been 32-42% lower. 

The second assumption is that the default of these two firms and five customers at each 

would be completely unexpected by the DCOs. That is, there would be no prior 

evidence that either of these two firms or its customers were experiencing financial 

trouble. Past experience has shown that there would be some indication of the financial 

deterioration of the firms. In such circumstances the following would likely occur to 

lower the risk profiles of the firms: 

 Customers might proactively transfer to another firm, with which they already 

have a relationship, potentially reducing the risk exposure of the firm. 

 DCOs might require additional initial margin from the firms. 

 The firms might require additional initial margin from the customers. 

 In anticipation of liquidity needs, DCOs might delay the time in which they enter 

into reverse repurchase agreements. This could increase liquidity available to 

DCOs. 

 DCOs could request the firms to decrease their risk exposures. 
12

Upon completion of the analysis, staff sent the applicable stress test results, by 

currency, to each DCO. Each DCO independently confirmed that the calculations were 

accurate. 

E. Review of Clearinghouse Liquidity Procedures 

Each day, the CFTC receives extensive position and margin data. This enables staff to 

conduct credit stress tests at the individual account and clearing firm levels on a daily 

basis. By contrast, the CFTC does not routinely receive all the data that would be 

necessary to assess liquidity at DCOs with the same frequency. 

Moreover, DCOs have options to choose from when generating liquidity and the CFTC 

would not be making those choices. Therefore, a necessary step in this exercise was for 

staff to send the results of the stress scenario to each clearinghouse and ask each one to 

explain in detail how the necessary liquidity would be generated if the specified clearing 

firms were to default under the specified circumstances. 

The clearinghouses were instructed to assume that both firms defaulted at 8:00 am EST. 

However, LCH adopted a more stringent timeframe in its response, and assumed the 

default took place at 7:00 am UK time, giving it 6 hours less time to source liquidity. 

Each DCO provided a detailed written response. Staff carefully reviewed the responses 

and all the documentation provided by the DCOs. Staff then held multiple meetings 

with each DCO to obtain answers to follow-up questions. 

Staff then conducted interviews with three firms that had been identified by the DCOs 

as liquidity providers. The firms confirmed to staff that they would be able to enter into 

transactions with the DCOs to provide cash in the amounts and in the currencies 

required within the necessary timeframes. The two U.S. firms interviewed are primary 

dealers in the Treasury market and act as market-makers in the Treasury and FX 

markets. 

Finally, staff reviewed data from independent third-party sources. Staff used this data 

to confirm the reasonableness of the DCOs’ results. 
13

III. Results

A. Use of Non-public Information 

In conducting this exercise, staff made use of non-public information submitted by 

DCOs. Therefore, staff may not identify in this report the clearing firms whose positions 

generated the hypothetical stress losses. Nor can staff reveal the precise dollar 

amounts required under the stress test or identify the specific methods used by each 

DCO for generating liquidity. Nevertheless, staff believes that the aggregated 

information that is presented here provides evidence to support the conclusions. 

 

B. Size of the Liquidity Demand 

The aggregate stress test results created a liquidity demand from two firms across the 

three clearinghouses of $13 billion. This is the equivalent of 59% of the aggregate 

variation margin (VM) paid by all firms to the DCOs included in the exercise on the day 

following the Brexit referendum. That day was the largest aggregate VM flow day in 

recent history. Exhibit 5 depicts how that day compared to typical days. 

Exhibit 5: Daily Variation Margin in 2016
14

On the day after Brexit, the two firms which generated the largest pays accounted for 

only 21% of aggregate variation margin. Thus, this exercise created almost three times 

as much liquidity demand as would have been created if the two largest firms had 

defaulted following Brexit. 

C. Clearinghouse Methods for Generating Liquidity

DCO 1 

This DCO stated that it would have met the liquidity needs generated in this exercise by 

using cash from a maturing reverse repurchase agreement and by selling direct 

investments in short dated Treasury securities. Staff confirmed with the reverserepurchase counterparties that the DCO regularly performed reverse-repurchase 

transactions for the amounts indicated by the DCO. 

The DCO also has an understanding with the reverse-repurchase counterparties in which 

the counterparties agree to facilitate the selling of the direct investments. Staff 

discussed and confirmed this understanding with the counterparties. The 

counterparties also confirmed that the type and the amount of securities that needed to 

be sold could be easily handled by the market. 

DCO 2 

This DCO stated that it would meet its liquidity needs in a variety of ways depending on 

the specific currency. The DCO would access cash balances at a central bank, use cash 

from maturing reverse-repurchase agreements, enter into repurchase agreements using 

securities in the specific currency, and use larger exposure currencies to obtain cash 

through the foreign exchange (FX) spot market for smaller exposure currencies. 

With respect to the reverse-repurchase agreements, the DCO had numerous 

counterparties. Therefore, if one failed to return the cash the following morning, the 

DCO would still have sufficient cash from the remaining counterparties. Staff confirmed 

with a reverse-repurchase counterparty that the DCO regularly performed reverserepurchase transactions for the amounts indicated by the DCO. 

 

With respect to repurchase agreements using securities in a particular currency to 

obtain cash in that currency, the DCO actually tested its ability to execute the 

repurchase agreement with eight counterparties. The DCO determined that it would 

have been possible to raise all of the cash with a single counterparty. 
15

The DCO also tested its ability to exchange larger exposure currencies for smaller 

exposure currencies in the FX market. The DCO determined that it would not have to 

liquidate any of the defaulted firm’s non-cash collateral to generate the cash liquidity. 

For a variety of reasons, the complexity of the investments at this DCO was slightly 

greater than at the other DCOs. A liquidity analysis is performed by the DCO before 

determining the amount of cash to be invested each day in reverse-repurchase 

agreements. 

DCO 3

This DCO stated that it would meet its liquidity needs by accessing the defaulting firm’s 

cash on deposit and liquidating the defaulting firm’s collateral as well as the collateral in 

some of the DCO’s additional financial resources. The DCO provided staff with the 

specific type and maturity of securities to be liquidated. 

As part of this exercise the DCO contacted two firms it would consider using to liquidate 

the collateral and shared the amount and types of collateral to be liquidated. The DCO 

stated that, based on those discussions and its own experience, it believes the collateral 

could be liquidated for same-day cash within an hour or two. 

Staff also discussed the liquidation of the collateral with a liquidity provider. The 

liquidity provider stated that the normal practice is next-day settlement, but same-day 

settlement for cash is not a problem and that it does not necessarily mean the DCO 

would get a worse price. 

Using Bloomberg data, staff estimated that the costs to liquidate this DCO’s largest 

Treasury securities would be 1-1.5 bps under normal circumstances. However in a 

stressed market the cost would depend largely on the dealer's ability to liquidate in a 

short time frame, and could differ from the prevailing bid-ask spread. Even so, the 

liquidation cost would likely be small relative to the haircut, which is designed to protect 

against significant market movements. 

The liquidity provider stated that the first step to begin liquidation of the collateral 

would be for the DCO to provide immediate notice that it has ownership of the 

securities and intent to sell. The DCO would inform the buyer of the securities where 

the securities were located and could gain some efficiency if it could move the securities 
16

to an account in the DCO’s name affiliated with the buyer prior to the transaction. If the 

liquidity provider’s institution can locate the securities in an affiliated account, an 

interbank DVP (delivery versus payment) transaction can occur or a DVP transaction can 

occur between the DCO’s institution where the securities are located and the buyer’s 

institution. The DCO would work with the liquidity provider to monitor the securities 

sold and remaining to be sold. The DCO would then wire funds to a settlement bank in 

which it had a payment obligation. 

This DCO also used larger exposure currencies to obtain cash through the FX market for 

smaller exposure currencies. 

In instances where the DCO invested in various reverse-repurchase agreements that 

matured at different times across multiple time zones, staff confirmed with the DCO 

that amounts available for liquidity included only cash that would be available at the 

time of the defaults. 

D. Summary of Methods Used by Clearinghouses

Exhibit 6 summarizes the methods DCOs chose to generate liquidity in this exercise. 

Exhibit 6: Sources of Liquidity in this Exercise
17

In their submissions, DCOs provided documents illustrating the types of data used, and 

analysis conducted to help determine the preferred method of meeting liquidity needs 

in this default scenario. 

Data included collateral on deposit by type and currency in the defaulted accounts. 

Analysis included projections of liquidity needs by currency and account over a five day 

period, along with assets available to meet these needs. 

 

E. Effects across Clearinghouses

A goal of this exercise was to determine if any combination of the three DCOs would 

have the need to access the same source of liquidity and, if so, what effect that might 

have on the liquidity provider(s) and the market in general. The analysis below 

discusses the different types of liquidity that would be used by the DCOs and discusses 

whether two or more DCOs would have used the same method. 

Futures related defaults were denominated in USD only, while the IRS defaults 

encompassed multiple currencies. Much of the required liquidity was met with cash on 

hand in the form of commercial bank and central banks deposits or cash inflows from 

maturing repurchase agreements. DCOs were not relying on executing multiple 

transactions per currency to meet their liquidity needs. In no instance was more than 

one transaction per currency required to obtain the liquidity. 

With the exception of some small FX transactions, that would have occurred after Day 1, 

all requirements for Days 2 through 5 were available on Day 1. No additional liquidity 

transactions were required for Day 5. 

Cash from maturing reverse-repurchase agreements was a source of liquidity relied 

upon by more than one DCO. In the normal course of a maturing reverse-repo, the DCO 

would return the securities involved in the transaction to the counterparty and receive 

the cash back, or roll-over at the current market rate. The fact that such transactions 

might be performed by multiple DCOs, therefore, should not have a systemic effect on 

liquidity. 

Liquidating collateral was a source of liquidity relied upon by more than one DCO. Staff 

interviewed firms that the DCOs would contact to facilitate the liquidation of collateral. 

The same liquidity provider could be used by two DCOs to liquidate collateral. Staff 

consulted with the identified liquidity providers and made a determination that the 
18

collateral amounts were such that the providers would be able to meets the needs of 

the DCOs for same day funds without disrupting the market. 

In this regard, staff reviewed statistics of turnover in the markets for U.S. Treasury 

securities. The Treasury securities that these DCOs would have liquidated in this 

scenario represent less than 1% of average daily trading volume in those 

markets.5

 Thus, although the volume of securities liquidated in this exercise would be 

extremely large from the perspective of normal practice at the DCOs, this volume would 

not be systemically significant from the perspective of the overall market for U.S. 

Treasury securities. 

Moreover, DCOs routinely apply haircuts to collateral including Treasury securities. Staff 

took these into consideration in assessing the ability of DCOs to raise funds by 

liquidating such collateral. 

Because the amounts of FX on deposit with the DCOs were insufficient to meet payment 

obligations to firms, more than one DCO went into the FX market to obtain specific 

currencies. The level of activity involved here was extremely small in relation to the size 

of the FX markets. 

Finally, for two of the DCOs, the defaulting firm or an affiliate was a potential liquidity 

provider. For one DCO, the two firms/affiliates were liquidity providers in a resource 

that was not used to generate liquidity for this exercise and, therefore, their default did 

not affect the DCO’s ability to access liquidity. 

For the second DCO, the two firms were existing reverse-repurchase counterparties. As 

defaulted members, the securities posted by the firm as collateral for any reverserepurchase agreement would become available for liquidation. In any case, for 

purposes of this exercise, the DCO had sufficient cash from other sources to meet its 

obligations under the scenario. 

In fact, all three DCOs would have had sufficient liquidity to cover substantially more 

than the amounts required in this exercise. Each of the DCOs had alternative methods 

of obtaining liquidity that weren’t tapped here. These include for one or more DCOs: (i) 

 

5

See page 14 of the latest Treasury report available at https://www.treasury.gov/press-center/pressreleases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf] 
19

additional maturing reverse repos, (ii) additional collateral available for liquidation, (iii) 

DCO capital, and (iv) secured lines of credit. 

IV. Conclusions

The results of this exercise demonstrate that these clearinghouses had sufficient funding 

liquidity to meet the variation payments resulting from defaults by two very large firms 

and, as applicable, the five largest customers from each firm. This was accomplished 

despite the fact that simulated defaults occurred simultaneously across all 

clearinghouses included in the exercise. 

The methods relied upon to raise cash overlapped among the clearinghouses to some 

extent. The extent of the overlap, however, did not appear to present any systemic risk 

concerns. 

 

Some observers have expressed concern about liquidity risk at DCOs. The findings from 

this exercise provide evidence that could serve to mitigate these concerns to some 

extent. However, continued vigilance through active monitoring and future stress tests 

will be an essential part of the ongoing CFTC supervisory programs. 

 

V. Next Steps

As noted at the outset, this exercise is the second in a series of systemic stress tests 

involving derivatives clearinghouses. CFTC staff intends to continue to enhance its 

program to incorporate additional scenarios and sources of risk. The Next Steps section 

of the November 2016 Report listed a number of enhancements. One of them was 

liquidity risk, a risk factor examined in this exercise. Other enhancements listed 

included adding scenarios, adding products, and doing reverse stress tests. This exercise 

also included additional yield curve shifts in the stress scenarios. 

In its plans for future stress tests, staff plans to expand the scope of the exercises to 

include other risk factors. 

 Specifically with regard to funding liquidity risk, staff plans to design an 

exercise that addresses liquidity needs at the firm and account levels. It 

would include an analysis of at least the following areas: 

o issues, if any, on making variation payments across multiple time 

zones; 
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o the extent to which clearing firms generally advance funds to 

customers to meet variation payments in the customer origin; 

o issues, if any, on intra-day settlement cycles; and 

o the frequency and size of initial margin calls. 

 Another area that will be addressed in a future exercise is trading liquidity. 

Such an exercise would look at issues related to hedging, auctioning, and 

porting complex portfolios of a large number of customers in the event of a 

default by a very large clearing member. 

 Operational risk is another area of serious concern. A future exercise will 

address the effects of a system failure at a clearinghouse or a service 

provider. 

 The failure of a settlement bank, whether for operational or financial 

reasons, could have serious consequences. A future exercise will include that 

scenario. 

Finally, staff is actively working on automating its processes for conducting these 

exercises. The goal is to enable staff to conduct them much more frequently. It will also 

enable staff to combine more than one of these types of risk into a single exercise. 

Another benefit of more frequent exercises will be to allow staff to conduct analyses of 

trends within individual clearinghouses and across the industry.