OCC's credit rating placed on negative watch by S&P

OCC's credit rating placed on negative watch by S&P

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US equity derivatives clearing house OCC could see its credit rating cut by S&P after analysts at the agency placed it on negative watch.

In a note on Tuesday, S&P’s Thierry Grunspan and Matthew Albrecht said they are considering downgrading their 'AA+' long-term issuer rating on Chicago-based OCC.

The pair plan to “gather additional information” on the ongoing re-calibration of the company's clearing fund and re-assess its liquidity framework in a stress test.

OCC provides central counterparty (CCP) clearing and settlement services to 19 exchanges and trading platforms, covering options, financial futures, security futures and stock loan trades.

Post-crisis, a growing number of financial transactions have been funnelled into CCPs such as OCC as a result of new regulations. In the US, all derivatives deemed standardized must be cleared via a CCP. The EU and Asia are following the model in close succession.

However, given the size and required use of CCPs, regulators and ratings agencies are now scrutinizing how CCPs will manage a potential failure. There are also fears that the risk concentrated in CCPs represents a new single point of failure for the entire financial system.

From a loss-absorbing perspective, S&P points out that OCC sizes its financial resources using a 'cover 1' basis,” supplemented by various add-ons including a "prudential margin of safety," currently set at $1.8bn.

This means that in a stress scenario and under extreme-but-plausible conditions, OCC would have enough resources to absorb clearing losses if the largest clearing member were to default. However, S&P claims that it could exhibit a shortfall if the largest two clearing members were to default at the same time.

“Although OCC's practice is consistent with US regulatory requirements, we view it as weaker than the "cover 2" that other US CCPs and most EU peers now meet," Grunspan and Albrecht said in their note.

In the US, CME and NYSE-owner ICE operate at a "cover 2" level based on the Commodity Futures Trading Commission's interpretation that the products they clear are "complex." Clearinghouses in the EU are required to meet at least a 'cover 2' from a loss-absorbing standpoint.

"Overall, we view the "cover 1" for OCC (from a loss-absorbing standpoint) as the main weakness to the rating, even though it's consistent with the US regulations applicable to it," S&P's note added.

Responding late on Monday, OCC pointed out that S&P's report notes that its financial safeguards exhibit certain strengths compared to its clearing house rivals.

These include the use of a two-day margin period of risk and the $1.8bn prudential margin of safety in the clearing fund above the 'cover 1' level.

“OCC is actively working with US and international regulators to implement enhancements to further strengthen its loss absorption capacity and liquidity resources based on conservative stress testing methodologies,” OCC added.

Earlier this year, the clearing house had a capital plan approved by the SEC, boosting its capitalization from $25m at the beginning of 2014 to $247m.


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