The European Commission wants the EU to be prepared for what it sees as the unlikely eventuality of the failure of central clearing houses (CCP).
CCPs serve as the link between two parties to a transaction (sales of bonds, shares, derivatives, raw materials). They aim to ensure that the transaction runs smoothly even if one of the parties defaults, and are therefore connected to all financial institutions active on the related markets. Their number and importance has doubled since 2009, according to the Vice-President of the European Commission, Valdis Dombrovskis. A large proportion of the €500 trillion in derivatives contracts concluded throughout the world are cleared by the 17 clearing houses located in Europe.
In May of this year, the European Securities and Markets Authority (ESMA) concluded that these 17 central counterparties were sufficiently financed to ride out the default of the two largest clearing entities active with regard to several counterparties.
These central clearing houses are already subjected to strict regulatory standards, under the EMIR regulation (on European market infrastructures). The proposal presented on Monday 28 November aims to complete this framework and to govern the recovery and resolution of these entities.
The Commission explains that these new rules contain provisions similar to those governing the recovery and resolution of banks ('BRRD' directive) and are based on international standards, even though they contain specific tools to take account of the differences between these entities and banks.
Central clearing houses would be obliged to draw up recovery plans including measures to overcome any form of financial difficulty calling for more resources than they have to manage default and more than they are required to hold under EMIR.
These recovery plans will include both the scenario of a default of one of the clearing members and the materialisation of other risks or losses for the central counterparty itself, connected to fraud or cyber-attacks, for instance. Recovery plans must not be based on any extraordinary public financial assistance, the Commission explains. They should be global, effective, transparent and allow the parties affected to measure the potential impact on themselves, define appropriate incentives and minimise the negative impact on stakeholders and the financial system. On the basis of these principles, the CCPs would be free to determine the best options and instruments for recovery. These instruments may include a 'cash call' option, in other words asking the clearing members to feed in more resources, for example. The recovery plans will be examined by the supervising authority.
The authorities responsible for the resolution of the central clearing house must put together resolution plans describing how they would be restructured and how their critical functions would be kept in place.
The Commission's plans will also give the competent authorities powers to intervene in the operations of CCPs if their viability is in danger, but before they reach the stage of default or if their actions could be harmful to their own financial stability. For instance, the resolution authorities would have the power to require a CCP to change certain business practices or its operational or legal structures. A CCP would be placed under resolution if it defaults or if its default seems likely, when no private-sector alternative is liable to prevent its default and when its default would threaten the public interest and financial stability.
The resolution will contain a number of tools to be used separately or in combination: selling vital functions of the CCP to a viable competitor, creating a publicly-controlled bridging company, allocating the losses and positions between the compensating members. The resolution authority would be free to decide which tool to use on the basis of the circumstances and in line with the resolution plan agreed at the College of resolution.
"There is no equivalence requirement for third country rules", Dombrovskis commented. The proposal is based on cooperation between resolution authorities, but "doesn't include provisions to ensure resolution decisions work across borders" outside the EU, he explained. As the rules presented by the Commission are based on international standards, the EU now expect its international partners to adopt a similar approach, the Vice-President went on to state.
Over at the European Parliament, Kay Swinburne (ECR, UK), who is to negotiate the dossier, said that she was looking forward to working to ensure that this legislation stays as close to the internationally agreed principles as possible. (Original version in French by Élodie Lamer)