Credit, Concentration and Wrong Way Risk
To safeguard the overall integrity of the Clearing House (Eurex) and to protect the mutualizing Clearing Fund, we conduct an internal credit assessment of all counterparties and perform continuous monitoring of credit, concentration and wrong-way risks. This enables us to guarantee fulfilment of all obligations towards counterparties even under extreme market conditions. Therefore, it is essential for us to monitor all risks arising from the trading portfolios of counterparties on the one hand, and from the collateral deposited to secure such portfolios, on the other hand.
From a Clearing House perspective a counterparty is a general term for Clearing Member and segregated Non-Clearing Member/Registered Customer. A counterparty’s portfolio is understood to contain all of its clearing activities such as:
- derivatives transactions
- spot market transactions
- Special Repo transactions, GC Pooling transactions and GC transactions,
- securities lending transactions
- pure cash positions.
- margin requirement,
- Clearing Fund contribution, and
- company capital requirement.
As most of the thresholds defined are referring to the notional exposure, we will determine this by taking into consideration both the counterparty’s portfolio and collateral pool. The value of the various product classes is calculated as follows:
- Cash: nominal value
- Equities: market price*number of shares
- Bonds/repos: market price*notional;
- Futures: position size*multiplier*underlying price
- Options: position size*multiplier*underlying price*delta
In a nutshell, we are dealing with three relevant types of risk:
- Credit risk is defined as the potential loss one party may suffer if the counterparty fails to fulfil the contractual obligations arising from its transactions.
- Concentration risk is defined as the potential loss which we may suffer during the Default Management Process, due to an insufficient diversification in respect of the counterparty’s collateral pool and transactions.
- Wrong-way risk is defined as the potential loss which Eurex Clearing may suffer during the Default Management Process, due to an unfavorable interrelatedness between the counterparty’s creditworthiness, the value of its collateral pool and the value of its portfolio.
To map these risks all counterparties, countries and supranational organizations are classified into one of multiple, pre-defined classifications according to a general five-color scheme containing five characteristics – green, yellow, orange, red and black.
Counterparties in a financial transaction face credit risk as an integral part of the overall risk they are exposed to within such business. In general, credit risk is defined as the potential loss one party may suffer if the counterparty fails to fulfil the contractual obligations arising from its transactions. As a central counterparty, Eurex Clearing is of course exposed to credit risk but since we are central counterparty to all your trades migrated to Eurex Clearing we also guarantee to fulfil all obligations towards non defaulting counterparties – even under extreme market conditions. Therefore it is part of our business to monitor all risks arising from the trading portfolios of counterparties on the one hand, and from the collateral deposited to secure such portfolios, on the other hand. In order to comply with our high standards, we conduct an internal credit assessment of all counterparties and guarantee continuous monitoring of credit risks. The assessment is triggered as follows:
- Initial credit assessment prior to granting a Clearing License
- Annual credit assessment of all counterparties
- Ad-hoc credit assessment, if deemed necessary
Based on these assessments each counterparty will be assigned to one of several pre-defined classifications. We inform all counterparties about their classification and any changes thereof. Furthermore, credit risk thresholds may be set as a control mechanism. The purpose of these is to reduce the risk of losses as a result of a counterparty’s default. Depending on the particular trading portfolio, credit risk thresholds can be defined either as maximum margin requirement and/or as maximum notional exposure arising from transactions conducted by the counterparty.
The Clearing Member classification also decides upon the applicable concentration and wrong-way risk thresholds for the respective counterparty, explained more in detail in the sections below.
We assume a portfolio or collateral pool to be concentrated if the exposure of a particular position exceeds the aggregated market demand during the anticipated liquidation period. Hereby, market demand depends on market capacity and on the credit quality of the particular security or instrument. If a counterparty has defaulted, we guarantee a safe and smooth wind-down of such counterparty’s portfolio – with the lowest possible market impact. In order to do so, we collect margin collateral from our counterparties, i.e. we require counterparties to secure the risk exposure arising from their respective portfolios. Additionally, we maintain a mutualizing Clearing Fund, as well as dedicated own resources to cover additional losses. The adequacy of these financial resources is continuously assessed and monitored.
Generally, margin collateral and contributions to the Clearing Fund can be made in cash collateral or non-cash collateral, aggregated in the collateral pool. If, as a consequence of a counterparty’s default, we have to liquidate large positions of collateral, such liquidation may cause losses due to a lack in liquidity. Similar losses can arise if the portfolio of the defaulted counterparty is concentrated in certain instruments, and we are confronted with a lack in liquidity when winding down the respective portfolio. To avoid such losses, dedicated concentration risk thresholds are defined, which are applicable to all counterparties. The currently valid concentration risk thresholds are shown in table 1:
Concentration risk thresholds which must not be breached
In addition to the counterparty classification, we process so-called country and supranational organization classifications, both of which are considered as input parameters for the definition of concentration risk thresholds. The classifications follow the same color scheme outlined in the general section, while details about the current classifications can be found in the Eurex Clearing Member Section on our website The currently applicable concentration risk thresholds are shown below. Please note that for these thresholds both the counterparty’s portfolio and the counterparty’s collateral pool are taken into account.
Concentration risk thresholds per country classification
Concentration risk thresholds per supranational organization classification
Wrong Way Risk
Another type of risk we are facing in case of a counterparty’s default is the one arising from instruments – which when being liquidated – are likely to decrease in value as they are linked to the credit quality of the counterparty. This kind of risk is referred to as wrong-way risk.
- "Same country" is defined as each respective counterparty’s home country;
- "Any country" is defined as all countries within the country classification, including the counterparty’s home country.