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III Default Management, 11 Default Management

David Horner

From: Clearing OTC Derivatives in Europe

Edited By: Bas Zebregs, Victor de Seriere, Rezah Stegeman, Patrick Pearson

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2023. All Rights Reserved.date: 14 April 2024

Credit risk — Default and credit — Derivatives — Clearing — Liquidity

This chapter addresses how strong default management capabilities are essential for any reputable clearing house to function. It seeks to understand how a modern central counterparty (CCP) prepares itself to be successful in this discipline. The chapter begins with a summary of the historical context, including the default of Lehman Brothers in 2008 and the European Market Infrastructure Regulation (EMIR) and Dodd–Frank legislation which followed. It then discusses the CCP’s financial resources: variation margin, initial margin (including for large, concentrated positions), skin in the game, the default fund, and the unfunded ‘deep waterfall’ tools. The chapter also describes important default management logistics such as default decision-making, hedging, auctions, client porting, and participation incentives. Finally, it examines the important role played by ‘fire drill’ exercises in ensuring that the CCP and its stakeholders are well prepared.

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