has been rather merciful in terms of CCPs’failures, the inherent cross-border and
international nature of their activities, their level of interconnectedness with other ﬁnancial
institutions and their growing importance following the G20 commitments on OTC
derivatives make them the critical nodes of the ﬁnancial system, the resolution of which
should be carefullyconsidered.
While a “naïve”application of the current resolution regimes for banks is tempting, the
speciﬁc business model of CCPs,in particular its approach to loss allocation in the case of a
default by one or more clearing participants, calls for a more cautious and tailor-made
approach (see Section 1.2 on the recoveryand resolution framework for CCPs).
We note that CCPs are subject todifferent risks (e.g. credit, liquidity, operational...)that
could threaten their viability.The underlying causes of these risks can be broadly classiﬁed
into two categories: default and non-default events. The Financial Stability Board
[FSB (2017b)]deﬁnes the latter as a loss incurred by CCPs for any reason other than the
default of a clearing participant. Examples of non-default events include losses on
investments or because of operational failures or fraud. This type of losses generally does
not entail any mutualised loss allocation mechanisms relying on clearingparticipants. This
means that the loss-absorbing capacity relies entirely on the CCPs’shareholders. In this
context, the interplay between resolution actions, shareholders’rights and the NCWO
principle is simpliﬁed and similar to the case of banks (see Section 3.1.1 below). Therefore,
the present paper focusses on the resolution of CCPs following the default of one or more
1.1 The role and function of a central clearing counterparty (CCP)
A CCP acts as the buyer to every seller and the seller to every buyer for a speciﬁed set of
contracts. Under normal circumstances, a CCP runs a “balanced”or “matched”book
between its ﬁnancial rights and obligations from and towards its clearing members.
However, if one or more clearing members fail to meet their payment obligations, an
unmatched book is created whereby the CCP is left with open directional positions vis-à-vis
its clearing members.
To avoid incurring losses and continue its activities, the CCP must then re-establish a
matched book. This is donevia a default management process based on a contractually pre-
agreed waterfall of ﬁnancial resources foreseen in the CCP’s operating rules. The waterfall
works with the defaulter paying ﬁrst and with the mutualisation of the tail-risk of having
remaining excess losses that willneed to be subsequently shared among clearing members.
Under the European market infrastructure regulation (EMIR), a portion of the capital of
the CCP is also designated to absorb losses before callingon the default fund contributions
of non-defaulting members. This “skin in the game” (SITG) should align incentives
between the CCP and its clearing members and encourage the CCP to manage its activities
and risks adequately.
To determine the amount of loss that enters the waterfall, the CCP runs an auction
process during which survivingclearing members are offered the possibility to bid for the
positions of the defaulting clearing member(s). This will likely be one of the ﬁrst measures
taken in recovery.
If the auctioning process has been unsuccessful or the waterfall is not sufﬁcient, the
CCP’s recovery measures would complement existing EMIR provisions, providing
additional recourseto surviving clearing members, notably under the form of:
Partial tear-up: This tool is designed to help the CCP return to a matched book and
crystallise its losses by allowing the CCP to cancel some of its open contracts with
surviving clearing members.