Overly prescriptive regulation could cause unnecessary constraint to central counterparties (CCPs), and could lead to more risk in the central clearing marketplace, according to a new report from the World Federation of Exchanges (WFE).
The paper pointed out CCPs’ strong track record in managing risk in times of market stress, and said they are best placed for managing the risk of their particular markets. Because of this, the report said, they should be allowed to maintain the flexibility to manage their own risk in a way best suited to their market.
Gavin Hill, head of regulatory affairs at WFE, said: "CCPs are the experts in their markets and need the flexibility to determine which emergency powers they need to manage events as they arise."
He added: "Exchanges and CCPs have demonstrated their resilience through several market crises and events in recent years. They are part of the solution."
A prescriptive one-size-fits-all regulation would: “unnecessarily constrain the exercise and deployment of specific CCP risk-management procedures, systemic insight and institutional knowledge to the potential detriment of the overriding goals of financial stability and fair, efficient and orderly markets,” the report argued.
The paper also supported a move to align the incentives of CCPs and clearing members. Clearing members should be incentivised to support those policies that encourage diversification of risk, and therefore greater stability, and should pay for their exposures.
CEO of WFE Nandini Sukumar said: "Exchanges and clearing houses care about systemic stability and the need to make markets safer, more transparent and more resilient."
She added: “The markets and businesses they operate daily require a high standard of integrity as well as robust risk management practices.”
"As markets evolve, WFE and its members will work with regulators and the industry to ensure this is the case.”
The paper comes as a response to concerns over the concentration of risk in CCPs, and the suggestion that they could be the next ‘too-big-to-fail’ institutions.
Generally, WFE approves of the Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO) Principles for Financial Market Infrastructure (PFMIs), designed to assist infrastructures in improving safety and efficiency, and to remove systemic risk.
However, the report also placed importance on the specialist knowledge of CCPs, highlighting their knowledge of their markets, and of the risk management tools most appropriate to their markets.
While WFE supports a drive to expand on central clearing practices to improve transparency and market stability, it argues that CCPs can facilitate this expansion, improving risk management practices and helping to develop new and innovative techniques for newly cleared products, particularly in emerging markets with very particular needs.
The report concluded that a blanket approach to regulating CCPs would undermine their ability to manage risk in the particular markets they serve, and would be contradictory to improving the stability of the central clearing model.
