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Law360, London (July 13, 2020, 3:05 PM BST) -- Europe's clearinghouses are resilient enough to withstand the economic crisis caused by the COVID-19 outbreak, Europe's markets watchdog said Monday as it published the results of its latest stress test on the sector.
Central counterparties, known as CCPs, have remained resilient throughout the pandemic despite increased volatility in markets and risks to their operations, the European Securities and Markets Authority said.
ESMA has probed the strength of CCPs, which absorb risks if a buyer or seller defaults in a derivatives transaction, in its 2019 annual stress test on the institutions. The authority said the scenarios against which it tested EU clearinghouses could be compared in severity to the economic fallout from the coronavirus crisis.
"CCPs are capable of withstanding severe shocks under common shocks and simultaneous defaults," Steven Maijoor, ESMA chairman, said. "This resilience was also demonstrated during the unexpected and unprecedented impact of the COVID-19 pandemic on the global financial system. This provides reassurance given the key role these market infrastructures play."
ESMA said that it found no systemic risk during the extreme stress scenarios that it tested CCPs against. The institutions hold sufficient liquid assets to weather the hypothetical storms — which included two clearing members defaulting as market prices tumble.
The simulations are designed to assess how robust the clearinghouse industry in the EU is and to alert regulators to potential risks. The European Union regulator said that it tested all 16 CCPs that are authorized to serve members based in the bloc, which include three clearinghouses in the U.K.
This is the third time ESMA has carried out the stress tests, which monitor potential systemic risk stemming from CCPs. The first round — which focused on the risk of default and market price shocks — took place in 2016.
Clearinghouses shoulder most of the risk of credit default for buyers and sellers when clearing and settling market transactions. This leaves them potentially exposed in case of crisis, which could send shocks such as lack of liquidity and credit loss across international markets.
--Additional reporting by Joanne Faulkner. Editing by Ed Harris.
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