EC tackling final questions on CCP resolution

Rules on the recovery and resolution of central counterparties (CCPs) are expected to take shape over the next couple of months, according to participants at a Brussels conference on financial reform yesterday – but key elements, including where to draw the line between recovery and resolution, still need to be settled. The regime will determine how catastrophic losses should be allocated among clearing house participants.

Two new regulatory documents are in the works. The first is a set of proposals from the European Commission on the rules that would apply if a piece of financial market infrastructure (FMI), including clearing houses, ran into trouble. The Committee on Payment and Settlement Systems (CPSS) is also working with the International Organization of Securities Commissions (Iosco) on further guidelines for FMIs – the two groups collaborated on a set of principles that were published in 2012 and are now used as the benchmark when judging CCP risk management. No international standards for recovery and resolution currently exist, despite the gradual adoption of rules that will require a big piece of the over-the-counter derivatives market to be cleared.

"With the clearing rules, we have put more pressure on CCPs and they are becoming more and more systemically important. That's why we now need recovery and resolution rules. We have worked very closely with the CPSS-Iosco working group on these issues but there are still a couple of open questions that will be discussed in the coming months," said Nicolas Gauthier, a policy officer within the EC's directorate-general for Internal Market and Services.

According to Gauthier, regulators are still trying to nail down the relationship between recovery and resolution – with the former helping to put a damaged entity back on an even keel, while the latter is an attempt to end the life of a mortally wounded institution in a humane fashion. Regulators will also need to work out when and how to call time on an unsuccessful recovery process and switch to resolution, and – finally – settle the role that different authorities will play in supervision, Gauthier said. He was speaking during a panel discussion at an event run jointly by the Centre for European Policy Studies (Ceps) and the International Swaps and Derivatives Association.

Another panellist, Uzma Wahhab, a member of the secretariat at the Financial Stability Board (FSB), brought up the CPSS-Iosco work, which she estimated would be published during the second half of the year.

There are still a couple of open questions that will be discussed in the coming months

According to a Brussels-based source who has been following the work, however, the CPSS-Iosco guidelines are likely to arrive in the third quarter, with the EC's proposals to follow shortly after.

Among other things, CPSS-Iosco's original FMI principles set expectations for the liquidity resources a CCP should have – the danger being that a clearing house might face a temporary shortfall in variation margin if one or more member firms were to default. For clearing houses that are systemically important, or that clear complex products, the requirement is set with reference to the possible shortfall that would be created if the two largest member firms collapsed. But there is no detail on how to cope with larger losses or other types of life-threatening events, which leaves a question about how these losses should be shared out among clearing house participants, potentially including clients of member firms – a controversial topic.

In the UK, the Financial Services and Markets Act of 2000 has already been amended to address CCP recovery and loss allocation measures, with those changes taking effect in February and May this year. The law now requires UK-regulated clearing houses such as LCH.Clearnet to have rules that would allocate losses "with a view to ensuring that the central counterparty can continue to provide the services and carry on the activities specified in its recognition order."

Speaking to Risk on the sidelines of yesterday's event, Michael Davie, LCH.Clearnet's chief executive, said the Bank of England had drawn up the framework to fill in a gap in Europe's clearing rules, the European Market Infrastructure Regulation (Emir). He added he is hoping the EC's proposals resemble the requirements now in place in the UK.

"When Emir was adopted back in 2012, the Bank of England recognised that the regulation did not tackle the question of recovery and resolution measures by CCPs and worked on its own framework. Although we don't know yet whether the EU rules will be tougher, we hope CCPs in the UK will be able to stick to the rules that are currently in place there," he said.