OCC also employs a two-day margin period of risk for its initial margin model, which exceeds the regulatory standards for exchange-traded derivatives of a one-day margin period of risk.

Margin models are not calibrated to cover 100 percent of the risks. CCPs utilize robust back-testing to assess the adequacy of its margin calibrations.

The margin period of risk (i.e., the estimated time needed to close out a defaulting counterparty's accounts), is another critical determination in calibrating appropriate margins. We believe the margin period of risk should be tied to the default management process. While the U.S. regulatory minimum margin period of risk for exchange-traded derivatives is one day, OCC believes that two days is more reflective of the practical timeframe needed to close out a defaulting counterparty's accounts, given the default management experience. OCC, therefore, sets the margin period of risk at the more conservative two days for its exchange-traded derivative products.

Many CCPs offer margin offsets for products that are economically and intuitively linked. These correlations must also be persistent and strong, and margin offsets should not be allowed for products that are tangentially correlated or in different asset classes. OCC runs de-correlation scenarios where there is an additional charge at a higher confidence level based on the greater of historical, zero, or perfect correlations of products to cover the risk of markets moving in a much different way than in the past.

Other considerations when reviewing margin models include daily calibrations, the length of lookback periods, liquidity add-ons, and concentration add-ons, wrong-way risk, and intraday margining capabilities, to name a few other important items.

Clearing Fund

Many of the considerations CCPs consider in establishing initial margin also apply to stress testing, as CCPs size their clearing funds at appropriate levels. This includes using several test scenarios, de-correlation scenarios, and long lookback periods. The regulatory minimum in the U.S. is "cover 1", meaning the CCP can cover the exposure of its largest clearing firm. In September 2018, OCC implemented a "cover 2" standard covering our two largest clearing firm exposures.

CCPs look to bring many similar products into clearing fund and default waterfall to allow them to be risk-managed together. A default waterfall refers to the financial safeguards available to a CCP to cover losses arising from a clearing member default and the order in which they would be expended. While a clearing member may not clear every product cleared by the CCP, it is important from a risk management perspective to have broad participation in a CCP clearing fund rather than small siloed funds for single products. If there is no recourse to access to other financial resources beyond the small siloed funds, a CCP default is more likely, which would be much more damaging to the customer, clearing firms, and the financial system.

Default Management

CCPs work closely with clearing member firms and other CCPs to design and test robust default management processes. This coordination includes vigorous testing of the auction process that includes participation from clearing members and clients. Of importance in the default management process and any stressed market environment is the CCPs’ ability to retain the flexibility to react to the facts and circumstances at the time, as each stress event typically looks very different from past events.

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