David Bailey, director of financial markets infrastructure at the Bank of England, said international regulators should co-operate on overseeing central clearing counterparties to avoid the long equivalence discussions that were needed between the US and Europe.
Bailey spoke at the Futures and Options World Post Trade Event in London yesterday. He said: “A repeat of the protracted equivalence discussions we have seen under the European Market Infrastructure Regulation would not be helpful.”
In February the European Commission and the United States Commodity Futures Commission announced a common approach to the regulation and supervision of CCPs after many years of discussions. The agreement allows European CCPs to do business in the US more easily and for US CCPs to continue to provide services to EU companies under Emir.
In 2009 the G20 began a regulatory push to move over-the-counter derivatives into CCPs so they can be netted, reported and made more transparent. However this has led to concerns that CCPs are becoming a new source of systemic risk to the global financial system and replacing banks as the new ‘Too Big To Fail’. In 2012 the global Principles for Financial Market Infrastructure were published requiring the largest CCPs to be able to withstand multiple member defaults in highly stressed markets and in 2014 standards were issued on how CCPs should develop their recovery plans.
Bailey said: “The UK has led the way in introducing legislation requiring CCPs to maintain recovery plans and all UK CCPs now have these arrangements in place. The UK has also legislated to extend its resolution regime to CCPs recognising the need to reduce reliance on public funds as a back stop in the event of a CCP failing and has been the first to form a crisis management group to facilitate the resolution planning of a CCP.”
However he added that more needs to be done to address the risks posed by the increasing systemic importance of CCPs and this is being coordinated by international regulators. The Bank of England believes more granularity is needed to set out what stress testing should incorporate and how it should be conducted in order to ensure international consistency.
“No two CCPs are exposed to the same sources of risk,” added Bailey. “Therefore to complement CCPs’ own stress tests it is also important that authorities explore how standardised stress tests could be developed across multiple CCPs both domestically and internationally.”
He continued that greater regulatory guidance could also be given to ensure international consistency on margin models. “Given the recent agreement between the CFTC and EU on a common approach to the supervision of CCPs, consideration should also be given to whether a standardised minimum margin period of risk should be embedded within the principles,” said Bailey.
The Bank of England also supports international harmonisation over CCP resolution. “This is particularly important as the EU Commission is developing its own legislative proposal on the recovery and resolution of CCPs but helpfully to a timetable which is designed to allow an international framework to be developed,” Davies added.
At the end of last year, more than half of the $384 (€338) trillion global OTC interest rate derivatives market and more than one-fifth of the $12 trillion credit derivatives market was centrally cleared according to Bailey. In the US certain interest rate swaps and index credit default swaps have been centrally cleared since 2013 and mandatory clearing will begin in the European Union next month.
“The proportion of derivatives being centrally cleared can be expected to increase significantly following the introduction of the EU’s first mandatory clearing obligations starting in June, and we expect to see the same trend for other asset classes,” said Bailey.
Last month the European Securities and Markets Authority published the results of stress testing 17 European CCPs who hold more than €150bn of default resources and have more than 900 clearing members. The European regulator said the CCPs’ resources were sufficient to cover losses resulting from the default of the largest two EU-wide clearing groups combined with historical and hypothetical market stress scenarios. Emir requires EU-wide stress tests of CCPs on an annual basis.
“However, under more severe stress scenarios, CCPs faced small amounts of total (i.e. across all CCPs) residual uncovered losses varying from €0.1bn up to €4bn Euros,” added Esma.
Steven Maijoor, chair of Esma said in a statement that the first EU-wide stress test of CCPs showed that they are well equipped to face the counterparty risk associated with the considered stress scenarios.
“However, Esma has also issued recommendations addressed to the national competent authorities of CCPs. These recommendations are aimed to ensure ongoing resilience which will require follow-up within CCP colleges,” Maijoor added.
Amir Khwaja, chief executive of analytics and research firm Clarus Financial Technology, said in a blog that the European CCP stress tests show that an implausibly large number of member firms would have to default e.g. 100 entities, to lead to uncovered losses of €28.9bn.
Khwaja added: “As the Esma study was published 15 months after the results were gathered, it would be prudent to run this exercise again, particularly as Emir mandatory clearing dates in 2016 are passed.”
The European Association of CCP Clearing Houses said in a statement that Esma’s report demonstrates that European CCPs are resilient and well equipped to withstand extreme market developments.
