Wrong Way Risk

As a central counterparty, BME CLEARING has exposure to both counterparties in a transaction and also has credit risk exposure to the issuers of the Margin Collateral accepted in the form of securities.

Both exposures are correlated with the credit quality of the counterparty and the issuer of the security.

If this credit quality suffers a downgrade, the risk of default increase and also the credit exposure, both against BME CLEARING.

This is what is called wrong way risk.

BME CLEARING has measures to avoid or at least mitigate the correlated collateral and the wrong way risk.

For example in the Cash Equities Segment, when stress test is done in securities within the Banking sector, in those securities where the issuer is also a Clearing Member in BME CLEARING, in one of the scenarios of the stress test a -50% downward price movement is applied to that security, applying to the rest of securities the fluctuations indicated in the Cash Equities Segment Circular “Stress Test Calculation Parameters”.

One example regarding mitigation of wrong way risk in the collateral posted in the form of securities are the Haircut Adjustment for the different Government Debts eligible as collateral but not included in the Reference Basket, based on the differential in respect of the latter. If the return on any Government Debt (eligible as collateral but not included in the Reference Basket) in the secondary market, as based on information obtained from the Reuters or Bloomberg agencies is higher than the return of the Reference Basket over two consecutive days, and according to the levels set out in the “Valuation of Securities posted as Margins” Circular, the haircuts of that particular Government Debt will be increased for bond buyer positions, resulting in an increase of the Initial Margin required.

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