When (and how) CCPs fail

There have only been three documented failures of CCPs: 1) the Paris-based Caisse de

Liquidation des Aiffaires en Merchandise – 1974; 2) the Kuala Lumpur Commodity

Clearing House (KLCCH) – 1983; 3) the Hong Kong Futures Exchange Clearing

Corporation (HKFECC) – 1987 (see Alloway, 2011). The failures shared a number of

crucial aspects: clearing members were unable to meet their margin requirement

obligations in times of financial distress, and the default funds were insufficient to absorb all financial losses.

The failure of the Paris Caisse is closely linked to the excessive degree of speculation that

was taking place in the white sugar market in 1974. Between November 1973 and

November 1974, the prices for white sugar increased by a factor of six (see Bignon and

Vuillemey, 2017, see also Chalmin, 1990). In Paris, white sugar prices further doubled

between September and November of 1974, before experiencing a fall on 21 November. The sudden crash of sugar prices hit several speculators, particularly brokers, many of

which were clearing members of the Paris Caisse and had been trading at those

speculative prices on behalf of their clients without authorisation by the CCP (Norman,

2011: 131). As the sugar prices were plunging, the Caisse issued several margin calls for

its sugar futures contracts. Due to the massive decline in profits, many clearing members

shortage. There was one particularly large sugar broker-firm, Maurice Nataf, which

underwent massive losses and was a member of the Caisse. In addition to the existing

problems in collecting margin requirements, the crisis took a turn for the worst when

Maurice Nataf announced to the Caisse that it would not be able to meet a margin call on

2 December (see Bignon and Vuillemey, 2017). The Caisse decided to close the market

and cease its activities on 3 December, which did not re-opened until January 1976 when

the Caisse was, in effect, liquidated, leading to the creation of a new CCP, the Banque Centrale de Compensation.

When it comes to the Malaysian KLCCH, the CCP had only been operating for about

three years prior to its failure, and its troubles derive from a crash in the futures market

for palm oil in 1983. Similar to what had previously happened with the Caisse in Paris,

the sudden decline in the price of palm oil led six clearing members to default on around

$70 million of palm oil futures contracts amid declining profits, which made them unable to meet the margin calls issued by KLCCH (see Gregory, 2014: 268). Just like in the

previous case, the Malaysian CCP shut down its market operations before failing

altogether thereafter. According to a Bank of England report, the Malaysian government

heavily criticised the ways in which the KLCCH handled the crash, as there had been a

12-day gap between the squeeze in the market and the brokers’ default, suggesting that

the CCP could have attempted issuing margin requirements beforehand (Hills et al.,

1999). Thus, as opposed to the Caisse, in the case of KLCCH a big responsibility lay in the inexperience of the CCPs’ managers, as well as the lack of coordination between the

CCP and the exchange in handling the crash (see Norman, 2011: 33). Still, the fact

remains that the inability to meet the KLCCH’s increases in margin requirements led to

Lastly, the failure of the HKFECC in 1987 brought a near-financial disaster in the global

economy. The clearing system in Hong Kong at the time was slightly more complex than

the other cases. Whereas the HKFECC was the institution managing the actual clearing

of the contracts traded on the Hong Kong Futures Exchange, the guarantor of these

contracts was a different institution, the Hong Kong Futures Guarantee Corporation

(HKFGC). The fragmented structure of the clearing system in Hong Kong created a

regime of moral hazard (see Gregory, 2014: 269). First, whereas HKFECC (the CCP) was responsible for monitoring the positions traded on the exchange, it was not exposed

to losses in case of default, which would have been borne by the HKFGC instead.

Secondly, while the HKFGC was exposed to the losses stemming from default risk, it had

no say in risk monitoring and standards, which were set by the HKFECC instead. Thus,

when the Hang Seng Index (the Hong Kong Stock Market index) experienced close to a

50% drop on 19 October 1987 – the so-called Black Monday – the Hong Kong clearing

system suffered from the lack of properly coordinated risk management practices, which had been reflected by the sustained price growth on futures prices during the previous

years (see Hills et al., 1999).

In a similar fashion to what happened to the previous two instances, traders were not able

to meet the sudden increase in margin requirements by the HKFGC following the price

drop. In that respect, the margin calls added a squeeze to their already limited available

liquidity. However, differently from Paris and Kuala Lumpur, the HKFGC actually had to be bailed out. After contributions from shareholders, members and large brokers, the

bailout still cost taxpayers around HK$1bn. Equally important, the crash in Hong Kong

could have compromised global financial transactions, as the local division of the

In light of the failure of CCPs discussed above, what can be said about the relationship

between the new key role CCPs in the OTC market and systemic stability? Firstly,

mandatory clearing does not reduce OTC derivatives risk per se, it transfers it from banks

to CCPs, which are perceived as more adept at managing counterparty risk. At the same

time, the increased exposure to the default risk of OTC derivatives traders means that the

‘systemic consequences of a CCP default could be unprecedented’ (Cœuré, 2014: 5). As

put by Financial Times editor Philip Stafford, CCPs have become ‘the new too-big-too- fail institutions’, an expression previously used to describe over exposed and thus

systemically important banks during the GFC (Stafford, 2017). Mandatory clearing

commitment has created new single failure points in the financial system, which may

actually be detrimental to financial stability. Therefore, I argue that mandatory clearing

may undermine the original intent of the G20 financial reform agenda, aimed at

improving systemic stability and preventing future tax payers’ bailout. The scope of the

changes brought about by the clearing mandate in the OTC derivatives market could prove to be dysfunctional, insofar as they simultaneously promote OTC derivatives risk

concentration and make the global financial system more prone to liquidity crises.

Back to liquidity, the three CCP crashes described above show that the sudden increase

in collateral requirements by CCPs can add pressure to the traders’ already weakening

funding availability during times of financial turmoil, effectively compromising their

ability to meet payments, including the margin calls themselves. This is a key finding when it comes to answering this project’s research question, which seeks to examine the

factors that contributed to destabilising sovereign debt markets during the euro crisis.

While LCH.Clearnet’s actions during the euro crisis did not lead to a full-blown liquidity

crisis, the CCP’s sudden increase in margin requirements did reduce the liquidity of

specific sovereign collateral markets, which added pressures on the funding liquidity

which LCH.Clearnet contributed to destabilising sovereign debt markets is funding

liquidity. The link connecting CCPs to liquidity will be explored in further detail in the

next chapter, which explores the functioning of repo market, the market segment where

most interbank lending operations are conducted and where LCH.Clearnet triggered its

large margin calls in the euro area from 2010 to 2012.