How should unfunded default fund contributions facing Qualifying and Non-qualifying CCPs be treated for leverage purposes?

Unfunded default fund contributions denote contributions that an institution acting as a clearing member has contractually committed to provide to a CCP after the CCP has depleted its funded default funds to cover losses the CCP incurs following the default of one or more of its clearing members.

Treatment of unfunded default fund contributions facing Qualifying CCPs:

Unfunded default funds facing Qualifying CCPs are not captured for RWA purposes. For Qualifying CCPs only pre-funded default funds are considered as risk positions in Articles 308 and 310. Also the fact that the definition of unfunded default funds is included in Article 309 that only applies for Non-qualifying CCPs demonstrates that unfunded default funds are not considered as a risk position with respect to Qualifying CCPs.

In order to be recognised as off-balance sheet risk position, an item would need to be assigned to one of the risk categories in Annex 1. In the context of unfunded default funds facing Qualifying CCPs, neither the CRR nor the respective Basel papers refer to off-balance sheet risk positions. Also the fact that the CRR requirements of Articles 300 to 311 “Own funds requirements for exposures to a central counterparty” are included in Part 3 Title II Chapter 6 “Counterparty credit risk” implies that these exposures should not be recognised as off-balance sheet risk positions.

For leverage purposes the EBA Q&A 2016_3014 provides that default funds that are recorded as an asset on the balance sheet should be reported as “other assets” and that for default funds that are considered as off-balance sheet items per the solvency framework the amount determined based on the solvency framework should be reported as an off-balance sheet item. As unfunded default funds facing Qualifying CCPs are not classified as off-balance sheet risk positions in the solvency framework and no amount is determined, they are not included in the leverage exposure.

This treatment is also consistent with our understanding of the regulatory intention. In order to promote central clearing the regulatory framework on both the international level as well as the CRR define various explicit beneficial treatments for Qualifying CCPs such as the exclusion of trade exposures from the CVA risk capital charge or the exclusion of trade and default fund exposures from the large exposure limit. If unfunded default contributions facing Qualifying CCPs would be included in the leverage exposure, clearing brokers would be forced to include the charge for the implied cost of leverage usage in their clearing fees to the customers. This would run counter to the regulatory objective of promoting clearing via Qualifying CCPs and reducing the cost of clearing.

Treatment of unfunded default fund contributions facing Non-qualifying CCPs:

The situation is different for unfunded default funds facing Non-qualifying CCPs. Unfunded default funds are defined in Article 309, i.e. specifically for Non-qualifying CCPs. In addition unfunded default funds facing Non-qualifying CCPs are explicitly captured for RWA purposes. RWA is determined as the product of 1.2, 1,250% and the notional of the unfunded default fund.

Accordingly unfunded default funds facing Non-qualifying CCPs – although not explicitly referred to as off-balance sheet risk positions in the CRR – are treated analogously to off-balance sheet risk positions for RWA purposes and should consequently be captured also in the leverage exposure to provide for consistency of regulatory guidance in regards to capital items (i.e., RWA and leverage ratio).

This treatment is also consistent with EBA Q&A 2016_3014 as unfunded default funds facing Non-qualifying CCPs are for RWA purposes treated analogously to off-balance sheet risk positions subject to a conversion factor of 100%.