As a central counterparty, KPEI is required to have and maintain sufficient financial resources to face Clearing Members counterparty risk which has profound implications on the market. The financial resources required need to be estimated by KPEI regularly to determine its adequacy in the face of extreme but plausible market conditions.
Based on Principles for Financial Market Infrastructure (PFMI) set by International Organization of Securities Commissions (IOSCO), central counterparties are advised to do a review on a regular basis regarding the methodology used in conducting stress tests to measure its financial resources needs. Stress testing is a method to estimate the extreme loss (but possible) abnormal market conditions by recalculating the value of the portfolio using the price changes that exceed the highest price change used in Historical Simulation VaR (HSVaR). Stress testing scenarios conducted by KPEI only covers market risks i.e. the risk that should be borne by KPEI due to the market price movements.
KPEI uses one type of stress testing; the Monte Carlo Simulation. Monte Carlo Simulation is the process of repeatedly running random simulations on models built on individual risk components resulting in portfolio value that may occur at particular horizon targets using 10,000 iterations. In this simulation, a variety of risk factors and operational data with a particular period is selected, and will be analyzed to determine the distribution type and its parameters, to be combined into a single model. The output of this model is the value of risk that should be covered by exchange transactions’ financial resources. Next, the portfolio will be simulated 10,000 times through iteration to generate the distribution of possible financial resource needs. Furthermore, by using the VaR approach, the exchange transaction financial resources need is determined by a certain confidence level.