A discussion paper from the European Commission has been sent to Member States ahead of a draft regulatory proposal that will include recovery and resolution plans, known as living wills, for non-bank entities such as clearing houses and other market infrastructure. The draft regulation is expected in the coming months.
The focus on avoiding taxpayer bailouts links to other points in the paper that suggest a clearing house default could lead to “a possible shutdown of entire markets, with knock-on effects even on markets not directly affected and spillovers for the real economy”.
The rules are being developed in response to reforms of the $600 trillion over-the-counter derivatives market, which has historically been largely managed privately between counterparties. Many swap trades will soon need to be guaranteed using a clearing house, leading to fears that risk will be concentrated at these entities.
The discussion paper asks for opinions on the process that a clearing house should follow to cover large losses, which could occur if several of its members were to default simultaneously.
The paper states that developing a recovery plan should be the responsibility of the clearing house itself, adding that indirect participants – buyside firms, clearing house owners and shareholders – could also be exposed to losses. It asks for opinions on the definition of resolution and the involvement of central banks in these scenarios.
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