What's the Point of Stress Testing Without Granularity?

So last week in this space I provided my "final thoughts" from the FIA Boca 2015 conference that I attended. Well, that may have been premature.

Also at that conference was a panel discussion on stress testing. Executives representing JPMorgan, CME Group, LCH.Clearnet, the US Securities and Exchange Commission and Greenwich Associates all endorsed the Committee on Payments and Market Infrastructures (CMPI) and the International Organization of Securities Commissions (IOSCO) plan to review stress-testing guidelines for central counterparties (CCP).

Specifically, they said that standardized stress tests are considered "desirable" for CCPs, but where the fight begins is when it comes to the granularity of the data provided.

In short, Sunil Cutinho, president of CME Clearing, the clearing arm of CME Group, was advocating against stringent granularity because each CCP has a significantly different risk profile, while David Weisbrod, chief executive officer of LCH.Clearnet, LLC, said that it was important not to dumb the test down, otherwise, what's the point?

Cutinho: "I don't think that there's a disagreement on standardization. We love the effort from CPMI. The issue is about getting too granular. You can't get too granular because the risk profile of the CCPs are fairly different. The products that the CCPs clear are quite different. So trying to attempt one single stress test that fits all CCPs will not be a successful effort."

Weisbrod: "How you do a standardized stress test, across jurisdictions and multiple products with different CCPs and different risk management standards is a task. But, it's one that we are engaged in and supportive of and that we think will be beneficial. We agree with the goal. We want to make sure that it incorporates all the necessary detail so that we don't dumb it down ─ in other words, reduce it to the lowest common denominator ─ and therefore inadvertently create more risk than we're trying to fix."

I'm hesitant to give an opinion here, so simply let me ask a few questions: What would be the point of not enforcing stringent stress-test guidelines? Isn't the word "stringent" basically implied in the words "stress test" in the first place? While it may cost more, and while CCPs have different risk profiles, isn't granularity important to determine relative health during distressed markets? And, additionally, shouldn't at least part of those results be released to the market, in addition to the regulators?

I'm not an expert, so I'd like to know more. Feel free to shoot me an email or give me a call at 646-490-3973. But right now, I'm firmly in favor of more granularity.

But, I also agree with another point that Cutinho made: Client clearers should be subjected to stress tests, as well:

"From a client's perspective, if coming through a clearing firm, it is important for clearing firms to also submit themselves to stress tests, because when a clearing member fails, there are implications for its client," he said. "In the US we have a specific capital requirement for clearing members of 8 percent of gross margin that they have to maintain, but there is no stress testing on them. So if we are going to stress test, let's go all the way and look not at just one aspect of the chain, but at the member firms as well as the CCPs."

Five Random Thoughts/Links:

● For those who think that John Oliver, the host of "Last Week Tonight", should take over for Jon Stewart after he leaves the "Daily Show" later this year, you're crazy. Every single Monday, social media and blogs are afire with whatever Oliver covered the night before. Because he's not a daily, he gets some time to think on, and perfect, a segment. Why lose that kind of platform, voice and power? [Be warned, strong use of a certain four-letter F-word contained in that link/clip.]

● As a proud Plattsburgh State University alumnus, I'd like to congratulate the Cardinals on winning their second-straight NCAA (D3) Women's National Championship in hockey.

My colleague, Tim Bourgaize Murray, a Franklin & Marshall alum, tried to rub it in that his alma mater beat mine in baseball this past weekend, 22-5. But, to be fair, that game was played down in Florida. Let's see how the Diplomats do playing a mid-March game up in the North Country. (Also, my school won a National Championship...so nah, nah, nah, nah, nah.)

● Uber cars now outnumber yellow cabs in New York City. I'm OK with that, if I'm being honest. Oh, and the MTA subway fare hike went into effect this past weekend. So now, if you live in Williamsburg (like me), you can spend $2.75 to be crammed into the L, or you can walk down to North 6th and Kent and take the East River Ferry (like me). Trust me when I say that the ERF is the only way to travel.

● Apparently there were numerous "data problems" in a report delivered to Group of 20 finance officials and it "ignored the impact of the leverage ratio," according to my colleagues over on Risk.

● If you're looking for a few excellent reads on two brilliant mathematicians, allow me to highly-recommend this New Yorker profile of Yitang Zhang and how he solved a "pure-math mystery", and this profile in Nautilus of Walter Pitts and how he rose up from homelessness to lay the foundation for cybernetics and artificial intelligence.