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The EACH response to the Financial Stability Board (FSB) discussion note on ‘Essential Aspects of CCP Resolution Planning’ is published today. In this response, EACH identifies the relevant aspects of CCP resolution that are core to the design of effective resolution strategies, including:
- Extremeness of this potential event – The mostly likely scenario that would result in a CCP being placed into resolution is the simultaneous default (and failure of resolution) of multiple large clearing members. The market stress and losses would have far surpassed any scenario that could be deemed ‘extreme but plausible’ as defined by regulators.
- Robustness of existing CCP resources - European CCPs are already able to withstand extreme but plausible default circumstances (i.e. the default of their two largest clearing members) as well the potential winding down or restructuring of the CCP’s operations as a result of non-default event. Resolution would therefore be triggered by a scenario far worse than what is considered extreme but plausible.
- Recovery must be given every opportunity to work - A CCP should only be put in resolution once the CCP’s default management and recovery tools and processes are exhausted or have proven ineffective, or the CCP is materially breaching its core obligations as described in the CCP’s rulebook.
- Importance of flexibility – While the resolution authority should use the set of tools prescribed in the CCP’s rulebook, the resolution authority should keep a certain degree of flexibility to apply such tools to a different magnitude or in a different order from the CCP’s approach. This framework of ‘constrained flexibility’ would optimise the potential intervention of the resolution authority.
- Importance of incentives – EACH welcomes the FSB’s confirmation of the importance of maintaining the incentive structure of a CCP. The CCP's waterfall, and within it the default fund, are designed to not only provide a substantial buffer of collateral to cover counterparty credit risk, but also to ensure that the participants in the system have appropriate incentives to manage the risk they bring to the CCP and to participate appropriately in the default management process.
- Importance of restoring a matched book – EACH welcomes the FSB’s confirmation of the importance of the need to restore a matched book as soon as possible. A matched book is a key feature of the CCP’s risk management framework as it ensures that all of the positions that bring risk to the CCP have been adequately dealt with and the CCP operator has no ongoing market exposure.
- Global consistency – Legislators and regulators must ensure a consistent application of the recovery and resolution framework principles at an international level, given that CCPs may operate in multiple jurisdictions and clear products which are traded globally. We therefore welcome the efforts of the FSB to ensure a comprehensive set of guidelines that can be applied across jurisdictions, while adequately accounting for the specificities of different jurisdictions, CCPs, and the products and markets for which they clear.
