Credit, concentration & wrong way risk

Counterparties in a financial transaction face credit risk as an integral part of the overall risk they are exposed to within such business. As a central counterparty, Eurex Clearing is exposed to credit risk. However, since Eurex Clearing is a central counterparty to all your trades, it guarantees 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. To comply with the 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. Eurex Clearing informs all counterparties about their classification and any changes thereof. Furthermore, credit risk limits may be set as a control mechanism. The purpose of the limits is to reduce the risk of losses because of a counterparty’s default. Depending on the portfolio, credit risk limits 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 coincides with the applicable concentration and wrong-way risk limits for the respective counterparty, explained more in detail in the sections below.

Eurex Clearing considers a portfolio or collateral pool to be concentrated if the exposure of a positions exceed the aggregated market capacity during the anticipated liquidation period.

If a counterparty defaults, Eurex Clearing applies its default management process to minimize market impact. We collect margin collateral from counterparties to cover risk and maintain a mutualized Default Fund as well as dedicated own resources for additional losses. The adequacy of these financial resources is continuously assessed.

Margin collateral and contributions to the Default Fund can be cash or non-cash collateral. Liquidating large positions in case of a default may cause losses if there is low liquidity. To prevent this, Eurex Clearing sets concentration risk limits for all counterparties, applicable per Clearing Member. 

In addition to the counterparty classification, Eurex Clearing applies country and supranational organization classifications, both of which are considered as input parameters for the definition of concentration risk limits. The classifications follow the same color scheme outlined in the general section. Details about the current classifications can be found in the Member Section.

Please note that the country specific type limit includes sovereign, local government and agency issuer of the country.

The current concentration risk limits are shown in table 1, table 2 and table 3:

For listed fixed income derivatives, the concentration limits are not applicable, i.e. the exposures of these instruments are not taken into consideration while assessing the general concentration limits as outlined in the tables above. For listed fixed income derivatives, a separate concentration monitoring and early warning system is in place. Clearing Members are proactively contacted in case the share of open interest for an individual instrument exceeds 30%. 

For more details related to the booking of Supplementary Margin related to listed fixed income derivatives please refer to the Support section.

The complete set of concentration risk limits are available in the Member Section under the following path: Resources > Eurex Clearing > Documentation & Files > Risk Parameters.
 

Another risk Eurex Clearing faces if a counterparty defaults is that the value of certain instruments may drop when liquidated because they are tied to the counterparty’s credit quality. This is known as wrong-way risk.

To avoid wrong-way risk, Eurex Clearing generally does not allow counterparties to deposit own or issues of closely linked entities' as collateral. Moreover, counterparties are not entitled to use such instruments as collateral for repo transactions.

In case Clearing Members enter into positions, where they are exposed to the performance of their own stock (e.g. derivatives on their own stock) or other instruments issued by themselves or entities belonging to the same legal group, these positions are collateralized based on the assumption that the underlying becomes worthless in a default scenario. Resources which have already been provided to secure these positions (i.e. dedicated Total Margin Requirement on single position level as well as derived Default Fund contributions) are deducted before the final Supplementary Margin for the own issue positions is calculated. A daily monitoring process ensures a tight control of any own issue position. For a more efficient collateral management process on the Clearing Member side, the Supplementary Margins are charged weekly based on the largest excess (i.e. loss given default minus already provided resources) over the previous week. For more details related to the booking of Supplementary Margin related to own issues please refer to the Support section.

By defining dedicated wrong-way risk limits, Eurex Clearing is taking additional steps to minimize such risk. These limits are applicable to a counterparty’s collateral pool and the counterparty’s notional exposure. In this context, Eurex Clearing sets limits that consider the home country of the counterparty and the home country of the issuers within the counterparty’s collateral pool and portfolio. Thus, we either refer to "Same country" or "Any country":

• "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.

The complete set of wrong-way risk limits are available in the Member Section under the following path: Resources > Eurex Clearing > Documentation & Files > Risk Parameters.

The same handling for listed fixed income derivatives as outlined above for concentration limits applies to wrong-way risk limits, i.e. the exposures of these instruments are not taken into consideration while assessing the general wrong-way risk limits.