As CCPs are designed to be shock absorbers at the centre of the financial system, damage to a CCP presents risks to the system as a whole. In order to ensure that what has been designed as a shock absorber does not under stress become a shock transmitter, CCPs not only hold collateral from their members, they are required to hold additional default funds large enough to cover the default of their two largest members. This default fund includes the CCPs own capital. And they are able to call for further resources from their members under their recovery plans if these funds are exhausted. Notwithstanding the high level of resilience that has been achieved in this area, I think there are three important ‘prudential risk’ challenges for CCPs going forward. The first is to ensure that CCPs are prudent and require enough collateral, or ‘margin’, from their counterparties in good times to ensure they are protected in times of stress against movement in financial asset prices and in counterparty credit worthiness. CCPs use mathematical models to calculate, on the basis of past and potential market moves, the size of the risks they need to insure against. Posting margin to a CCP is a cost for a CCP counterparty and its clients. CCPs need strong internal systems and controls to ensure that over time, commercial pressures and competition from other CCPs do not lead to inadequate margining.
These central counterparties (known as CCPs), originally developed to manage the risks in agricultural commodity contracts, to act as intermediaries, taking and adjusting collateral from both sides to a financial contract so that if one party fails during the lifetime of the contract and cannot meet its obligations, the parties with whom they have traded are protected. 3  All speeches are available online at www.bankofengland.co.uk/speeches  3  But regulators and central banks however have had quite a hand in the making of these pipes and in mandating their use and terms of access – as a way of reducing risk in the system. The CLS international payment system, for example, was created by the FX industry, after much prodding from central banks, as a way of addressing regulatory concerns about the level of settlement risk in the system following the failure of Herstatt bank in the 1970s. Similarly, in response to regulatory demands post crisis, market participants have developed the role of CCPs to enable central clearing of a widening range of financial contracts. And, in line with their role in encouraging the creation and use of these systems, authorities internationally have long taken a close interest in their regulation and supervision. In 1990 the G10 Governors established the Committee on Payment and Settlement Systems (CPSS), with a membership that was enlarged to include 25 central banks in subsequent years. In 2014, CPSS was renamed to become the Committee on Payments and Market Infrastructures (CPMI).