Clearing Members and clients of the Futures Industry Association (FIA) and ISDA welcome HM Treasury’s (HMT) proposals for an expanded resolution regime for UK central counterparties (CCPs), which due to the UK’s active participation and contributions, are mostly in line with international guidelines and are closely aligned with the EU’s CCP Recovery & Resolution framework.
Resilient and robust clearing is extremely important to the Associations’ membership. The Associations have been significantly involved in the discussion on CCP recovery and resolution, including developing tools like variation margin gains haircutting (VMGH) and partial tear-up (PTU).
The Associations are broadly in agreement with the proposed framework, but have the following key comments and recommendations:
- Due to the global nature of UK CCPs, the Associations recommend including language in the UK’s final framework that the resolution authority will have due regard to financial stability implications for third countries when resolving a failed CCP.
- The current proposal would disproportionately allocate losses to clearing members despite the inclusion of a no creditor worse off (NCWO) framework.
- The Associations recommend the inclusion of compensation for clearing participants (clearing members and their clients) for all losses in recovery and resolution.
- The power to suspend early termination rights needs to be more clearly defined to ensure it does not impact legal netting.
- The Associations question the appropriateness of the CCP in resolution determining a “commercially reasonable tear up price”, especially in light of the fact that PTU is not considered a tool for loss allocation.
- The Associations welcome that the NCWO safeguard includes fewer indirect costs that are difficult to value (like for instance re-hedging cost under stressed market conditions or cost for margin at a new CCP) but would appreciate more details to fully assess the proposal.
- The Associations welcome the introduction of a second tranche of CCP skin in the game, yet they propose that the second tranche should be at a minimum the size of the first tranche, given that UK CCPs are globally systemically important.
- The Associations strongly recommend not to use cash calls to cover non-default losses (NDL), as these risks are solely managed by the CCP. CCP equity should be right-sized to deal with potential NDL.
- The Associations do not agree that loss allocation tools, such as cash calls or VMGH, should be used for recapitalizing a failed CCP. This is particularly so when such tools may be utilized without passing the ownership of the CCP to the clearing participants who provided the new capital.
- The Associations welcome that initial margin is excluded from the write-down tool. This however means that the only significant resource that can be written down will be the default fund; not only is it inappropriate to use this to cover NDL, it also places the majority of loss absorption on clearing members.
- While the Associations recognize certain advantages of the power to delay enforcement of a clearing member’s obligation, they strongly recommend HMT implements this power in an equitable manner and carefully analyses the interplay with the NCWO safeguard.
