CCPs to get multiple recovery planning tools

International regulators will lay out a range of tools to help central counterparties (CCPs) plan for their recovery should they run into trouble instead of specifying one approach, according to Benoît Coeuré, executive board member at the European Central Bank (ECB).

"Each CCP will be able to pick the tools it needs from the CPSS-Iosco report to plan for its recovery depending on its specificities and its balance-sheet structure, since the assets and liabilities can vary across institutions depending on their business models," says Coeuré in an interview with Risk.

The tools are understood to be part of a report focusing on CCP recovery and resolution, prepared jointly by the Committee on Payment and Settlement Systems (CPSS), the International Organization of Securities Commissions (Iosco) and the Financial Stability Board (FSB). This follows a CPSS-Iosco consultation on recovery of financial market infrastructures released in August 2013.

CPSS-Iosco will tackle the recovery aspect, while the FSB will focus on resolution. The report is expected to be published before the Group of 20 nations meets in Brisbane, Australia in November this year.

Coeuré did not describe the tools that will be proposed by the CPSS-Iosco report, but the August 2013 consultation paper set out a range of techniques CCPs can use for recovery purposes. It covered the allocation of default-related uncovered losses and non-default losses, how to deal with uncovered liquidity shortfalls, how to replenish financial resources and re-establish a matched book, and how to address structural weaknesses.

Each CCP will be able to pick the tools it needs from the CPSS-Iosco report to plan for its recovery depending on its specificities and its balance-sheet structure

Among these were controversial tools such as variation margin haircutting, which has provoked some strong views from the industry. While in theory allowing CCPs to choose their own recovery tools means that they could choose to avoid such controversial options, Coeuré says national regulators will be involved in the decisions as well.

However, two regulatory sources say that European regulators are split over how many recovery tools should be made available to CCPs.

"One regulator in particular is taking a very conservative stance and fears too many tools could disincentivise CCPs to run a strong risk management process that would avoid them falling into recovery," says one London-based source.

It is understood that national regulators will be responsible for developing CCP resolution measures, effectively giving them the power to decide when the recovery process stops and when resolution begins.

"We have to accept there is a grey area between recovery and resolution. For instance, authorities could decide to send a CCP into resolution for financial stability reasons, even though all recovery options have not been exhausted. This is why we had to address both issues in a consistent way", says Coeuré.

CPSS and Iosco released the initial Principles for Financial Market Infrastructures (PFMIs) in April 2012, which set out guidelines for national regulators to follow when implementing domestic rules governing key financial parties such as CCPs. A number of jurisdictions have already implemented the PFMIs. The next step is to design tools for PFMI recovery and resolution scenarios.

A Brussels-based regulatory source says the report will focus specifically on CCPs, with other financial market infrastructures being dealt with at a later stage.

"We understand that the CPSS-Iosco [report] will ask national regulators to focus on CCPs first as these institutions have now been recognised as systemically important and policy-makers are particularly keen to address any potential risk arising from those institutions as a priority," the source says.

Coeuré recognises that CCPs have now become "super systemically important" since the introduction of mandatory clearing: "As they are at the heart of the financial system, continuity of services is in their case even more important. Therefore, in extreme scenarios, they have to be able to act in a way that does not disrupt the system, and plan accordingly. That's why recovery and resolution rules are necessary," he says.

The publication of the report has suffered from delays, having been expected at the end of last year. According to Coeuré, this was because the two work streams were run in parallel and regulators needed to have discussions with the industry. "Then we had to accept there are trade-offs, meaning no single instrument or single tool can be deemed the ideal one either for recovery or for resolution," he says.