The global initiative to expand use of central clearing and central counterparties (CCPs) in over-the-counter (OTC) trades is making progress but still has significant hurdles to overcome, according to Jerome Powell, governor of the US Federal Reserve.
He assessed the ongoing plans in a speech at The New International Financial System: Analysing the Cumulative Impact of Regulatory Reform annual banking conference in Chicago on 6 November.
Powell explained that the swift growth of the OTC market pre-crisis, and the light regulations at the time led to “unmeasured and underappreciated” levels of risk, and that the crisis revealed huge failures in the system as it was.
In 2009, the G20 countries introduced the new principals for financial market infrastructures (PFMI), stating that they must all be centrally cleared to reduce systemic risk. Since then, Powell stated, about 20 percent of credit derivatives are centrally cleared, along with 45 percent of interest rate derivatives.
Despite this, Powell insisted there is much more work to be done, specifically, integrating central clearing and CCPs in to the wider financial system.
He said: “Governments firmly resolved that even the largest financial institutions must be allowed to fail and be resolved without taxpayer support and without threatening the broader financial system or the economy.”
“CCPs therefore need to adapt to a world in which their largest clearing members will be allowed to fail and to be resolved without taxpayer support.”
These adaptations include additional regulation and supervision, vigilance in maintaining liquidity and working towards even greater transparency, and offering clearing members access to stress test results that are comprehensive enough to produce concrete data.
Stressing the importance of global cooperation, Powell said: “The failure of a large clearing member that is also a key service provider could disrupt the smooth and efficient operation of one or multiple CCPs, and vice versa.”
“In the event of disorderly CCP failures, the netting benefits and other efficiencies that CCPs offer would be lost at a point when the financial system is already under significant stress. Ultimately, the system as a whole is only as strong as its weakest link.”
Despite its challenges, Powell maintained that the results of PFMI are generally positive, and the post-crisis reforms are leading to greater financial stability. But he stressed that it is “important not to be lulled into a false sense of security that past performance is a guarantee of future CCP success.”
He added: “It is imperative that we consider central clearing from a system-wide perspective, and that regulators will need to continue to work collaboratively with each other, both domestically and internationally.”
