The establishment of a recovery and resolution regime for financial markets infrastructures is one of the last remaining elements of the post-crisis reform agenda for financial services in the European Union (EU). CCPs emerge from the market infrastructure reforms as the new ‘too big to fail’ institutions, after the implementation of clearing obligations for over the counter (OTC) derivatives through EMIR in 2012, and the implementation of trading obligations for shares and derivatives through MiFID II/MiFIR.
About the Central Counterparty Recovery and Resolution Regulation
Following the publication of several editions of guidelines at an international level (by the Financial Stability Board (FSB) on CCP resolution, and by the Committee on Payments and Market Infrastructures (CPMI-IOSCO) on CCP resilience and recovery), the European Commission released its own proposal for an EU regulation in November 2016. Authorities in Europe have deemed necessary to have the adequate powers to step in when a CCP fails, and to be able to deal with it in an orderly manner.. On 23 June 2020, European authorities reached a political deal on the European regulation. Following the finalisation of some technical points, the political agreement should be submitted for endorsement by Member States’ ambassadors to the EU with a view to reaching a final agreement in late summer 2020.
In spring 2018, CPMI-IOSCO published guidance on supervisory stress testing of CCPs and a report on the follow-up Level 3 assessment of CCPs’ recovery planning, coverage of financial resources and liquidity stress testing. Further guidance is expected at the international level, in particular from the FSB which launched a consultation regarding financial resources for CCP resolution in November 2018 and another consultation in May 2020 related to guidance on financial resources to support the CCP resolution and on the treatment of CCP equity in resolution.
Scope
The EU regulation would be applicable to all EU CCPs
The proposal requires CCPs to draw up recovery plans, which would include measures to overcome any form of financial distress exceeding the CCPs’ pre-funded resources. This should include scenarios based on a clearing default by members of the CCP, and other non-default scenarios, such as fraud or cyberattacks. Recovery plans are to be reviewed by the CCP’s supervisory authority. The regulation should reinforce the role of CCP Equity in recovery and resolution situations.
CCP supervisors are granted specific powers to intervene in the operations of CCPs where their viability is at risk – even before they reach the point of activating the recovery or suffer an actual failure. Supervisors could also require the CCP to undertake specific actions (“Early Intervention”) or to change its business strategy, legal or operational structure, or its recovery plan. Nonetheless, theregulation should outline the list of tools available to the RA (with the ban of some specific tools).
A CCP will be placed in resolution when it is failing, when no private sector alternative can avert the failure, and when its failure would jeopardise the public interest and financial stability. EU Member States should designate a Resolution Authority, which will be responsible for preparing resolution plans outlining how their respective CCPs would be restructured and their critical functions maintained in this event.
Industry Implications
Central clearing is based on two fundamental principles: risk sharing and, if need be, acceptance of loss-sharing for the benefit of preserving a greater value and maintaining the cleared portfolio as intact as possible. Thus, one major issue is to define who would contribute to loss allocation.
CCPs will certainly have to comply with further transparency requirements and increase resources available for the default management process.
Banks mainly face a higher cost of risk. They may also need to review risk policies regarding CCPs and clearing clients due to new rules on recovery and resolution tools, and on loss allocation.
Clearing brokers may need to make new disclosures to clients and potentially amend clearing contracts so that they reflect liabilities and rights that may result from CCP recovery and resolution.
Negotiations in Brussels have shown slow progress notably due to the lack of international consensus as well as the political developments around Brexit, but the regulation should see the light in 2020.
Securities Services’ view
We welcome this EU initiative to establish a resolution and recovery regime for CCPs. Its primary aim should be to preserve market stability, to ensure service continuity, and to avoid contagion effects.
This initiative should also respect the existing rules under EMIR on CCP governance, risk management, and default management process. Where necessary, it should integrate those rules so as to guarantee more robust CCPs with greater capacity to sustain and manage internal crisis situations.
Furthermore, the CCP recovery and resolution regime should strike a balance between the risk-related and commercial concerns of the CCPs, and those of the clearing members and their clients.
There should also be distinct rules for loss-allocation in default-induced crises and in non-default loss scenarios. In the latter case, the responsibility should be primarily upon the CCP and losses should not be shared among clearing participants. Additionally, resilience situations preceding non-default scenarios should have greater supervision in order to further limit resolutions scenarios. The default waterfall should be fully protected from non-default losses. Initial Margins should be bankruptcy remote.
Key Dates
August 2016 – CPMI-IOSCO and FSB consultations on CCP resilience, recovery and resolution. Publication of joint reports
November 2016 – EU Commission proposal for a framework for the recovery and resolution of CCPs
December 2017 – Draft Presidency Report by the Estonian Council Presidency published
January 2018 – European Parliament adopts its position on the Commission proposal, Council position still pending. New reports to be expected from FSB and CPMI – IOSCO
November 2018 – FSB consultation on financial resources for CCP resolution and the treatment of CCP equity in resolution launched
June 2020 – Political trilogue agreement between Council, European Parliament and the European Commission reached on CCP R&R
Q4 2020 – Expected application date of the European Commission text proposal
