Systemic Risk Council Urges Action on Resolution of Central Counterparty Clearing Houses

WASHINGTON, D.C.—On March 18, 2019, the Systemic Risk Council (SRC) responded to the Financial Stability Board’s (FSB) late-2018 Discussion Paper on the resolution of distressed central counterparty clearing houses (CCPs).

Commenting that the Discussion Paper “is as welcome as it is overdue” given that many of today’s CCPs are “super systemic” and so too important to fail, the SRC emphasizes that the resolution of CCPs is “one of the biggest gaps in the post-crisis regime for financial stability.” Chair of the SRC Paul Tucker said: “We are urging the Financial Stability Board to take decisive steps to ensure that there are clearly understood and credible resolution plans for these hugely important clearing houses to be able to get through failure without a global calamity.”

SRC does not believe that the in-life recovery plans of CCPs will always suffice, and that in some circumstances they could have the perverse effect of transforming CCPs from being risk absorbers to being systemic-risk transmitters and amplifiers. In consequence, credible resolution powers and plans are vital.

SRC urges the FSB to articulate clear high-level principles that all such CCP-resolution regimes should satisfy. In the interest of creating healthy incentives for CCPs, SRC recommends that those principles should include the equity of CCP owners being wiped out upon entry into resolution (or special bankruptcy).

SRC makes a number of recommendations: on restrictions that should apply to the exercise of CCP’s in-life recovery plans; on the order in which their creditors should take losses in resolution; and for extra resources to absorb losses before operational liabilities (such as margin obligations and cleared contracts) are haircut or torn up. Those extra resources could include subordinated bonds, held by CCP owners or clearing members, that could be “bailed-in” as part of resolution; third-party insurance against some losses; and, most ambitiously, an internationally mutualised default fund to which all globally systemic CCPs would contribute.

If the FSB or its key members were to conclude that (something like) the SRC’s proposals could not work in the event of a systemic CCP’s failure, then it might be necessary to question the current model (structure, governance, ownership) of CCPs.

This is a field that can seem highly technical, but individual clearing houses have failed in the past and if and when they do in the future the social costs will alarm legislators and the public.

Read the full letter here.