Read the full FEDS working paper at: https://www.federalreserve.gov/feeds/feeds.htm
Edward L. Anderson, Fernando Cerezetti, and Mark Manning | Stress testing has become an increasingly important mechanism to support a variety of financial stability objectives. Stress tests can be used to test the individual resilience of a single entity or to assess the system-wide vulnerabilities of a network. This article examines the role of supervisory stress testing of central counterparties (CCPs), which has emerged in recent years. A key message is that crucial differences in CCPs' role, risk profile and financial structure, when compared to banks, are likely to require significant adaptation in the design of supervisory stress tests (SSTs). We examine how supervisory stress tests may be designed to complement CCPs' own daily stress tests, and argue that macro-prudential supervisory stress testing of CCPs is valuable for both authorities and market participants. The paper offers practical guidance on the implementation of the exercises and proposes some specific design principles that should allow authorities to extract more information from such tests. We propose a two-tier approach that meets the intended policy objectives, while balancing ambition and resource cost. The first tier encompasses more standardized tests that can be conducted frequently to assess the resilience of the clearing network over time. The second tier encompasses less frequent and more complex 'deep dive' assessments. The proposed approach should overcome operational and resource challenges, which to date, may have inhibited the widespread application of supervisory stress testing.