Why Is a CCP Failure Very Unlikely?

Central counterparties (CCPs) are designed to be robust enough to withstand generally at least the simultaneous default of their largest two clearing members in extreme but plausible market conditions. This is called a 'cover 2' CCP. However, the extreme-and-implausible case cannot be excluded i.e. where the CCP would exhaust all funded financial resources (i.e. skin-in-the-game and the default fund D) to cover the default losses and would need to resort to unfunded recovery tools. The aim of this paper is to consider the resilience of a CCP for both default losses and non-default losses. For the former case, it is shown under plausible assumptions that the assessment (or cash call) for the surviving members is sufficient to recover a cover 1 CCP provided that the total assessment powers under the CCP Rulebook equals 2D. Given the extreme scenario we also take into account that some surviving clearing members might decide to leave the CCP. Some intuitive results for the cover 2 CCP case are provided as well. For the latter case, it is demonstrated that under plausible assumptions, the likelihood that a non-default loss is larger than the CCP's capital including one year of profits, is equivalent to an AAA risk. These observations together provide substantiation for the very low likelihood of a CCP's failure.