CCP recovery and resolution: preventing a financial catastrophe

Author:Randy Priem
Position:Department of Clearing and Settlement, Financial Services and Markets Authority, Brussels, Belgium
Pages:351-364
SUMMARY

Purpose This paper aims to discuss the European Commission’s proposal for a central counterparty (CCP) recovery and resolution regulation. In this respect, the paper comments the consequences, risks and attention points for CCPs and their authorities. Design/methodology/approach This paper focuses on the proposed rules surrounding CCP recovery and resolution. The paper... (see full summary)

 
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CCP recovery and resolution:
preventing a nancial catastrophe
Randy Priem
Department of Clearing and Settlement,
Financial Services and Markets Authority, Brussels, Belgium
Abstract
Purpose This paper aimsto discuss the EuropeanCommissions proposal for a central counterparty (CCP)
recovery and resolutionregulation. In this respect, the paper comments the consequences, risksand attention
points for CCPsand their authorities.
Design/methodology/approach This paper focuses on the proposedrules surrounding CCP recovery
and resolution.The paper rst familiarizes the reader with the risk management procedurescurrently obliged
before discussingthe resolution and recovery provisions foreseen in the proposal.
Findings The proposed regulationcommands signicant requirements for CCPs and for their regulators.
Not only will CCPs haveto draft a recovery plan but also a resolution authoritywill need to be assigned. The
latter will havethe task, in consultation with a resolution college,to draft a resolution plan. When a resolution
is inevitable, authorities will need to assure the continuation of the CCPs critical functions, thereby
warrantingnancial stability and investor protection.
Originality/value To the best of the authors knowledge,there are no other papers that provide a holistic
overview of the newly proposed regulationand describe the choices to be made during a CCPs resolution.
This paper will be of interest to allCCPs and their stakeholders, such as their regulators, clearing members
and their clientsand other linked nancial market infrastructures.
Keywords Financial stability, Default, Investor protection, CCP, Clearing members
Paper type General review
1. Introduction
The desire of the G20 to centrally clear standardisedover-the-counterderivatives, reected in
the US Dodd-Frank Act and in the European Market Infrastructure Regulation (EMIR), has
substantially increased the importance of central counterparties (CCPs), which are nancial
market infrastructures that interposethemselves between market participants to reduce and
centralise counterparty risk. Indeed, according to the derivative statistics of the Bank for
InternationalSettlements, on averagemore than 50 per cent of the US$493tn globalmarket in
over-the-counter derivatives was centrally cleared in 2015. As discussed by Elliot (2013),
CCPs can be considered as the backbone of the nancial system and are mostly too
importantto failbecause of their interconnectedness with othernancial institutionsand the
increasedvolumes of clearing thoughCCPs, leading to a hugeconcentration risk.
That is, a sudden default of a CCP would put a halt to the trading and settlement of
nancial instruments, thereby interrupting nancial markets and potentially causing
liquidity problems for clearing members and their clients. A CCP thus acts as a rewall
under normal circumstances but could spread a nancial disease to the entire economy in
case of a sudden and/or unorderlydefault.
Luckily, the failure of a CCP can be consideredas a tail of the tailrisk, where e.g. three
or more large clearing members, typically globalsystemically important institutions, failed
on their own payment obligations,thereby causing nancial problems for the CCP. As credit
Preventing a
nancial
catastrophe
351
Journalof Financial Regulation
andCompliance
Vol.26 No. 3, 2018
pp. 351-364
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-03-2017-0032
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm

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