The European Commission is set to publish its long-awaited framework for clearinghouse recovery and resolution in the coming days, and will give national authorities wide-ranging powers to take over management of the business and clearing process.
Under final Regulation text seen by IFR, European resolution authorities are permitted to intervene in a CCP at any time they consider it is failing or is likely to fail. In the case of “early intervention” they have a range of options, from requiring the CCP to update its recovery plan to insisting on a change in the CCP’s business strategy or replenishment of financial resources.
Where there is an infringement of law, regulations or CCP rules, or a significant deterioration in the financial situation of a CCP, authorities are permitted to remove the senior management or board in its entirety and replace it with a hand-picked team.
The imminent publication of the new rules follows detailed guidance from the Commodity Futures Trading Commission in July for US CCP recovery and resolution and the adoption of comprehensive frameworks in the US and Europe for bank recovery and resolution published in 2015.
CCPs place themselves between the buyers and seller of trades, effectively guaranteeing the obligations between the counterparties and theoretically protecting both against the default of the other. They have played an increasingly important role in clearing of over-the-counter derivatives since the financial crisis, and around US$106trn of interest rate swaps have been cleared this year, according to ISDA SwapsInfo.
Because they run a matched book CCPs have little need for large stores of capital. Instead they are protected against the risk of member default through a “waterfall” of liabilities setting out who will pay. If the waterfall runs out, or looks like it might do so, resolution comes into play.
In the Regulation the EC says resolution can take the form of the sale of the CCP to a competitor, creation of a publicly-owned bridge CCP and allocation of losses and positions among clearing members. In respect of the latter, the rules specify a range of tools that regulators can bring to bear, including controversial margin haircutting, which has been opposed by some market participants.
“The various loss and position allocation options would provide the resolution authority with means to re-match the CCP’s book, stem further losses and obtain additional resources to recapitalise the CCP,” the Regulation says. “Resolution can take the share of further auctions of the defaulters positions…forced allocation of those positions…a partial or full tear-up of contracts, further haircuts of outgoing variation margin payments…and a write down of capital and debt issued by the CCP.”
In the worst case scenario the CCP can be liquidated using insolvency proceedings or funding can be provided by the central bank of the country in which the CCP is based.
One area of concern for market participants that appears not to have been addressed in the Regulation is the exact timing of any intervention by national authorities. Without specific rules, clearing members may seek to secure additional protections up front, one banker at a European house said.
“Jurisdictions are given a large amount of discretion over the timing of intervention and then whether they would look to implement a recovery plan or go for resolution,” said the banker. “If we have a rule-based approach then as a member you can plan ahead and assess where those decisions might fall, but if we don’t know what is going to happen then we might for example be more inclined to push CCPs to ring-fence something like initial margin.”