[ESMA91-372-2811 ] Opinion on CCP backtesting

ESMA published its Opinion on CCP back testing requirements under Article 49 EMIR and Article 49 of DelReg (EU) 153/2013. Back testing is a crucial aspect of risk management in financial markets and is used to assess the reliability and adequacy of margin models employed by CCPs.
The document differentiates between two key types of back tests: core model back testing and margin adequacy back testing.
Core model back testing is primarily concerned with evaluating the performance of a CCP’s margin model. It aims to demonstrate the model’s ability to achieve a specified confidence interval. This involves assessing how accurately the model’s statistical components forecast loss distributions and identifying any potential weaknesses in the model. ESMA notes the importance of considering “exceptions“ or instances where actual losses surpass the margins held for specific accounts. It recommends the utilization of both unit and portfolio back tests when evaluating margin models, ensuring that exceptions are not clustered within particular risk profiles. It also highlights the significance of accounting for margin add-ons, which cover various risk factors not included in the core margin models.
Margin adequacy back testing, on the other hand, focuses on assessing whether a CCP has maintained an adequate level of initial margin to cover potential losses in the event of a clearing member’s default. This type of back testing considers real portfolios guaranteed by the CCP, including unsettled transactions. It also takes into account the margin requirement of the clearing member at the time of the theoretical default. As in Core model back testing, in Margin adequacy back testing, it is recommended to exclude margin add-ons unless they account for risks that are already reflected in the historical price data.