The Bank of England has carried out a research project using data from DTCC and Unavista. The project modelled the flow of liquidity to meet margin calls in the cleared and uncleared market. The outcome of shortfalls is then compared to the global repo market to determine if systemic risk is present.

In a December research paper from the BoE 'Simulating liquidity stress in the derivatives market' the team modelled the flow of liquidity to meet margin calls in the cleared and uncleared market. The outcome of shortfalls is then compared to the global repo market to determine if systemic risk is present.

Data on cleared and uncleared OTC positions was received from DTCC and Unavista and limited to positions within the view of the BoE. Positions included those which reference a sterling financial instrument and at least one UK counterparty. The cleared positions were limited to those in SwapClear and FXClear. The paper lists the entities involved in the study, the outcome is anonymised.

The approach to the simulation included:

• Modelling the first line of funding and any immediate shortfalls
• The second line of funding (having to use the Repo market) and circular dependencies
• Scenario changes driven by swap rates
• Scenatio changes due to FX rates
• IRS and FX Swaps
• Treating corporate groups as individual entities and as a consolidated group
• Dependencies in the flow and timing of VM payments
• Flows to and from CCPs and between Clearing Members for uncleared positions

The outputs and analysis suggest that:

• Flows in the FX market were proportionally higher than in the IR market due to the large percentage swings in FX rates in the simulation
• Treating groups as consolidated entities significantly reduces any funding shortfalls, as they handle their internal flows and assets without recourse to external entities
• Most shortfalls were of direct funding, and only a small amount due to circular dependencies between entities
• Some entities showed large shortfalls when funding their cleared positions, others their uncleared positions
• The largest shortfall was for the largest entity in the cleared market
• The overall contribution to aggregate shortfalls was influenced heavily by smaller firms (see Figure 7 on page 23)
• Further steps by regulators could require more capital for firms with shortfalls in this model (but highly theoretical given the constraints on this project)
• Overall the total shortfall from this simulation amounted to 10% of the global Repo market

Download the BoE paper here: https://www.bankofengland.co.uk/working-paper/2019/simulating-liquidity-stress-in-the-derivatives-market