COVID-19 is having a remarkable impact on the global financial markets. In the last few days major indexes, such as S&P 500, reported unprecedented downward swings while market volatility ramped up. With even more turbulent times ahead, central clearing counterparties (CCPs) must prepare for potential failures of their participating clearing members (CMs), and potential downstream effects of disruptions at other clearing houses.
At FNA we have made great efforts to compile all publicly available data to map connections between CCPs and their participating CMs. Our platform transforms these data sets into intuitive visualizations that can inform on “who is connected to who” in the global clearing network. An example is provided in the picture below, where we can easily observe the highly interconnected structure of the global clearing network. In this visualization, CCPs are depicted by diamonds while CMs are represented by circles. The colouring allows one to identify the geographical region of each entity: North America (blue), South America (cyan), Europe and Middle East (orange), Africa (red) and Asia-Pacific (green). Finally, the size of each entity reflects its ‘degree’, i.e., the number of participating CMs for CCPs and the number of participated CCPs for CMs.
We can also focus on the network structure around a specific CM. An interesting example is Einar Aas, a trader who used to operate in the Nordic Commodities Market. In September, 2018, Einar Aas defaulted on a margin call at NASDAQ Nordic. Below we display the contagion path through which the effects of Einar Aas’ failure could have spread across the entire clearing system.
Consider the leftmost point in the diagram as a starting point (Einar Aas himself). The first level of contagion is NASDAQ Nordic, the only CCP which was directly connected to Einar Aas. This CCP managed to cover the loss (€114m) generated by the Einar Aas insolvency, by setting up a contingency fund built on the contribution of the other non-defaulting CMs, which we display in the second level of contagion. Finally, the third level of contagion is occupied by the other CCPs which share at least one CM with NASDAQ Nordic.
It is interesting to imagine what could have happened if NASDAQ Nordic failed to manage the Einar Aas insolvency on their own. As it clearly emerges from the diagram, the participation of several CMs to multiple CCPs would have spread the effects of Einar Aas default to many other CCPs across the globe. This highlights the extremely interconnected nature of the global clearing network and how significant the systemic risk is within the industry. This risk alone is calling for new visualization tools and risk management framework which accounts for these pivotal features of financial markets. This call is stronger than ever in these days as the financial implications of the COVID-19 crisis are far from clear.
Further information can be found in this FIA article