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Special invited lecture by Benoît Cœuré, Member of the Executive Board of the ECB, at the Federal Reserve Bank of Chicago 2015 Symposium on Central Clearing, Chicago, 10 April 2015
But what is less clear at the moment is whether this can be done by having CCPs observe the existing, tough international standards, which have been introduced only relatively recently. Or whether there is a need for new requirements that are more demanding or more specific. And if so, how can we best do that in a way that preserves the benefits of central clearing, provides the right incentives to CCPs and to their clearing members, and strengthens the financial system as a whole?
These questions go to the heart of the current work by the two international standard-setting bodies most directly involved, the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), as well as by the Basel Committee for Banking Supervision (BCBS) and the Financial Stability Board (FSB). Today I will cover some of the issues authorities are tackling.
The global regulatory agenda implemented since the crisis has made CCPs considerably safer.
As a result of the G20’s commitment to introduce clearing obligations, CCPs have become “super-systemically important”, and ensuring their safety is thus critical. Over the past few years, the global regulators (CPMI-IOSCO, FSB and BCBS) have offered guidance in many areas to increase the resilience of CCPs and their participants. Let me give you four examples:
First, rigorous risk-management standards via the Principles for financial market infrastructures: the PFMI were adopted by CPMI-IOSCO in 2012, implementing ambitious standards covering every aspect of a CCP’s risk management framework. These Principles are significantly tougher than those they replace and their consistent implementation across jurisdictions is currently being monitored.
Second, guidance on CCP recovery and resolution: in 2014, as a supplement to the PFMI, CPMI-IOSCO published comprehensive guidance on financial market infrastructure (FMI) recovery. It considered the types of tools that CCPs and other FMIs can use to deal with severe financial problems that could threaten their existence. In addition, the FSB adopted a framework on FMI resolution.
Third, specific treatment of banks’ exposures to CCPs: the BCBS has revised its previous Basel II capital framework, which applied a zero capital charge to banks’ exposures to CCPs, in order to better capture the risks stemming from the financial system’s increasing reliance on CCPs. One of the main features of this revised framework is the preferential treatment given to exposures to qualifying CCPs, i.e. CCPs supervised in a manner consistent with the PFMI.
Finally, enhancing the understanding of CCP risks via increased transparency: in order to ensure CCPs are providing participants with the necessary information to evaluate the risks linked to clearing, CPMI and IOSCO have published two disclosure frameworks. The Disclosure Framework and Assessment Methodology, released in December 2012, and The Public Quantitative Disclosure Framework for CCPs, released in February 2015, which require CCPs to disclose information on topics such as the size of their credit risk, liquidity risk, collateral, margins, business risk, custody and investment risks. Let me add that public disclosure requirements are particularly important for indirect members who, unlike direct members, do not play a direct role in the CCP’s risk governance.
Should authorities be doing more to address potential weaknesses in CCP risk management?
As I just mentioned, the regulatory standards have been significantly strengthened since the financial crisis. However, catastrophic losses beyond those already covered by the regulatory requirements could still occur. Given the critical role of CCPs in financial markets, regulators need to think the unthinkable. Indeed, stress events concerning CCPs are – thankfully – rare: the most recent example of a CCP failure was the collapse of the Hong Kong Futures Exchange clearing house in 1987.
A more recent – albeit less dramatic – stress event was the uncertainty caused by the default of a clearing member at KRX, the South Korean CCP, which caused it to tap its mutualised default fund, and revealed that clearing members were not always aware of their potential liabilities towards the CCP. When such events occur, they have the potential to shut down the markets they serve. With the emergence of super-systemic CCPs serving global derivatives markets, a CCP failure could be a catastrophic event of global proportions.
In September 2014, the gross notional outstanding amount of centrally cleared positions was estimated at USD 169 trillion for OTC interest rate derivatives, and at USD 14 trillion for credit derivatives. The sheer magnitude of these figures (around ten times the GDP of the United States or European Union) gives us an idea of the severity of the potential consequences from a stress event at a major global CCP.
Authorities see the distinct benefits of central clearing and wish to set proper market incentives for participants to move away from bilateral trading and into the centrally cleared world. Mandatory central clearing allows risks to be pooled, monitored and properly managed. However, pushing more complex products towards mandatory central clearing makes risk management more challenging, and therefore may increase the risks to which CCPs and clearing members are exposed. Authorities may need to assess whether overly complex products should really be submitted to central clearing, so as to ensure CCPs can continue pooling risks in a safe and efficient way.
In recent months, concerns have been expressed regarding the adequacy and consistency of the level of risk management across the CCP landscape. At this stage, it is too early to say whether current regulations are insufficient. New requirements may well prove necessary but the impact and coverage of the existing regulatory framework should first be comprehensively assessed.
Authorities have started exploring and analysing potential issues with the granularity and consistency of global standards, and will continue to do so in the coming months. For instance, CPMI-IOSCO has put in place a substantial implementation monitoring programme of the PFMI across jurisdictions: the monitoring work so far has shown that many jurisdictions have made good progress in adopting the PFMI in their domestic regulatory frameworks. A more detailed analysis of whether the content and the outcome of implementing legislation, regulations and policies are complete and consistent is currently under way.
Furthermore, the granularity of margin practices is being reviewed, and CPMI-IOSCO is now assessing – in cooperation with the industry – the consistency of CCP stress testing practices. Consistency does not need to be achieved by imposing standardised models on all CCPs – a “one size fits all” approach may not be appropriate, and regulators may be more effective by relying instead on minimum standards, which all CCPs would be required to apply to their models. The outcome of these exercises will be of crucial importance in identifying and calibrating the need for further regulatory action.
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Conclusion
I have made the case that the global regulatory agenda implemented since the crisis has made CCPs considerably safer. If these requirements are applied consistently, significant improvements to CCP loss-absorbing capacities may not be required. CPMI and IOSCO are currently reviewing CCP risk-management practices on a global scale and will identify any areas where greater consistency or granularity is needed.
If the need did arise for further loss-absorption capacities, we will have to make sure any new requirements provide the right incentives for CCPs and their members, offer authorities a certain degree of flexibility and do not create disincentives for central clearing. Whether we choose to bolster the tools for CCP resilience, CCP recovery or CCP resolution, we will need to be aware of potential trade-offs in the way losses are allocated, and remember that there may be no ideal approach. I have provided an overview of the pros and cons of these various approaches.
It will be crucial not to lose sight of the systemic view when discussing CCP loss absorption, and to pay close attention to the interconnections between CCP exposures and bank exposures, and to the impact of CCP risk-management on pro-cyclicality in the global financial system.
I look forward to learning from our discussions today and I hope they will shed new light on some of the trade-offs I have identified.
Thank you for your attention.