Some of Europe's biggest clearing houses warned that a new European Union proposal that fails to exempt holders of derivatives from sharing losses when banks fail poses a risk to the region's fragile financial system.
The proposed law to "bail in" private investors, forcing them to take losses when banks fail, is part of a broader effort to prevent banking crises from bankrupting governments, as has happened in Ireland and Cyprus.
The latest draft proposals aim to give national authorities more control over which investors and creditors should suffer losses by removing an automatic exemption for liabilities arising out of centrally cleared derivatives transactions. The change reflects feedback from member countries that their national authorities should be given more flexibility in assigning losses, an EU official said.
An exemption would allow clearing houses "to correctly carry out their risk-management function" and thereby "contribute to financial stability", said the statement from the European Association of CCP Clearing Houses, or EACH. Central counterparties, or CCPs, stand between buyers and sellers of financial instruments. Using clearing houses is meant to ensure that even if one party to a trade fails, its counterparty wouldn't be affected. Some observers warn that such moves concentrate financial risk in clearing houses, creating new risks to financial stability.
Under the latest EU draft, national authorities would only be allowed to exempt derivatives if making holders absorb losses would "cause a destruction in value such that the losses borne by other creditors would be higher than if these liabilities were excluded from bail-in".
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