The World Federation of Exchanges (WFE) has called for a “careful and considered” approach in changing resolution arrangements at central counterparties (CCPs) to avoid damaging stability and increasing systemic risk.
In response to the Financial Stability Board’s (FSB) consultation on the treatment of CCP equity in resolution, the WFE highlighted that a fundamental element of central clearing’s value is the ability to address pre-specified contingencies within an incentive structure.
It suggested resolution measures should be examined in line with incentives for market participants to effectively operate in any default management and recovery processes, rather than assuming that increasing the CCP equity is always the right course of action.
The European Association of CCP Clearing Houses (EACH) also weighed in on the consultation, warning that compensating clearing members beyond the CCP guidelines could endanger taxpayers’ money, as the resolution authority could be vulnerable to potentially unlimited claims from clearing members.
The WFE, while recognising the FSB’s leadership on realism, also emphasised the importance of proposing a set of realistic and plausible scenarios when adjusting the treatment of CCP equity, rather than adjusting for extreme scenarios.
In terms of custodian and settlement bank failures, the WFE stated it does not believe CCP equity should be adjusted to bear losses for such events.
The WFE recommended that, in a scenario where CCP shareholders cannot support recovery, the FSB should not assume that CCP equity should be adjusted to bear losses, as this undermines the key incentives for shareholders to preserve franchise value.
EACH affirmed that each stakeholder in a non-default loss should take responsibility for the loss, to ensure allocation of the loss is proportional to the level of responsibility and/or advantages derived from a service of each stakeholder.
It was also highlighted by EACH that the FSB should consider that CCP stakeholders are always exposed to losses, and will therefore always bear losses, either in resolution or as a result of liquidation.
It was suggested that the No Creditor Worse Off than in Liquidation (NCWOL) safeguard should reflect the fiscal costs of shutting down a CCP.
Finally, EACH stipulated that timing of entry into resolution should be defined by the intervention of a resolution authority after exhaustion of resources in a CCP’s recovery plan. If early intervention occurs, it is important to highlight the legal responsibility of the resolution authority for the decisions made.
Nandini Sukumar, CEO of the WFE, explained: “The current treatment of CCP equity has been carefully determined, consistent with international standards, to promote incentives for market participants to back the risks they bring to the CCP, and thereby support the stability of the broader financial system.”
“An essential part of this consists of incentivising market participants’ effective participation in the default management and recovery processes. Creating potential rewards in resolution, such as exposing all CCP equity as a first-loss resource, could undermine the CCP’s resilience or its ability to recover.’’
