Central counterparties (CCPs) are already strong enough to withstand the ‘extreme but plausible’ scenario that would trigger a resolution strategy outlined by regulatory authorities, according to the European Association of CCP Clearing Houses (EACH).
Responding to the Financial Stability Board’s discussion note, Essential Aspects of CCP Resolution Planning, released in August, EACH highlighted aspects of CCP resolution that are core to the design of an effective strategy.
Stressing that European CCPs are robust enough to withstand the extreme but plausible circumstances that would lead to default, EACH noted that a resolution strategy would only be triggered by a situation significantly more serious.
It said that the most likely scenario that would lead to a CCP being placed in resolution would be the simultaneous default of several large CCPs. In a statement on the response, EACH said that, in this case “the market stress and losses would have far surpassed any scenario that could be deemed ‘extreme but plausible’ as defined by regulators”.
It added: “The resources held by CCPs will be sufficient to cover the vast majority of circumstances.”
However the association also noted that recovery must be given the chance to work as planned. The statement said: “Unless and until recovery is clearly ineffective or it is determined that continuing the recovery plan could result in greater losses for market participants, the recovery plan defined by the CCP should be permitted to run as anticipated by the market.”
EACH also noted the importance of flexibility of the resolution authority. Although in the resolution process the authority should use a set of tools prescribed in the CCP’s rulebook, it should also be flexible in its methods, in order to “optimise the potential intervention of the resolution authority”.
In its response, EACH welcomed the FSB’s confirmation of the importance of maintaining the incentive structure, saying: “CCPs are by design risk management and mutualisation systems.”
It noted that CCPs are designed to provide a buffer of collateral to cover counterparty credit risk, and that this ensures participants in the system have an incentive to manage the risk they bring to the CCP.
The current structure promoted good behaviour and aligns the interests of CCPs, clearing members, market participants and regulators, according to EACH.
A requirement for CCPs to reimburse members for a default management process could undermine the incentives for clearing members to make recovery work, and could change the “positive risk management features” that make CCPs stable.
In it’s statement on the response, the association also highlighted the importance of global consistency in recovery and resolution frameworks, “given that CCPs may operate in multiple jurisdictions and clear products which are traded globally”.
EACH therefore welcomed the FSB’s efforts to ensure a set of guidelines that can be applied cross-jurisdiction, while also accounting for specificities of each jurisdiction, as well as the different CCPs and the different products and markets they clear.
