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Cœuré addressed what he called "foundational questions" as part of a day-long review of the territory held at the US Treasury Department headquarters. He said the benefits are well known of routing derivative trades through central clearing houses, which assume the counterparty risk and spread any losses among members. But there are also possible side effects and unintended consequences to consider as well, he said.
Among those is the risk the clearing houses could themselves become a source of crisis contagion, transmitting any systemic damage as well as containing it. Cœuré pointed out that in the European context, advancing regulation can involve 70 people around the table, while in the US five regulatory agencies share the burden. Clearing houses can make losses more predictable and the way losses, if any, can be mutualised in the case of negative events. "We have to make sure those losses fall on actors that are able to handle them", he said. Central clearing entities "are of unprecedented systemic importance". So sound risk management is crucial within the clearing houses and "it is important that financial institutions that participate in CCPs can conduct effective due diligence to understand the risks they are facing".
"The mere fact that the same large financial institutions will become clearing members or are already clearing members of many CCPs increases" the chances of contagion. With clearing houses answering to a wide variety of regulators, there can be a "race to the bottom" as the least rigorous regulatory regimes neutralise the rest, he said. When banks are restricted from using clearing houses across borders it increases the chances of "fragmentation or de-globalisation of financial markets due to the difficulty of implementing a large number of new regulations" by many political jurisdictions, a retrogression the global system "cannot afford". Clearing operations are becoming increasingly large, he said, as seem to be "dominated by a few large global financial institutions" creating a lot of dependency on a small number of institutions. In addition, there are dangers some clearing operations could "cherry pick members", diminishing their institutional reach.
Disclosure and transparency can mitigate some risks, he went on to say. "My dream would be to have all of this converted at some point to some kind of common document" but an international conference "is a good start". A challenge is to require the correct size of capital buffers of the financial institutions while not putting up barriers to their participation in clearing networks, Cœuré said.
The Financial Stability Board and the International Association of Securities Commissions may settle on resolution regimes for CCPs by the middle of the year. Cœuré said he's not sure "we fully understood" the systemic implications of risk management decisions taken by CCPs. "Certainly, we don't want to - by focusing too much on the systemic obligations - to kill the notion of good risk management within CCPs so there is a very delicate tradeoff to achieve here", he said. "I would not exclude that there could be a need for further adaptation of regulatory reqirements for CCPs," but "certainly not now", he remarked. "The first step is to understand the the gaps" in regulation.
On the panel with Cœuré was Marcus Stanley, representing a US public interest coalition of more than 200 organisations concerned with financial system regulation, Americans for Financial Reform, who questioned whether the size of the derivatives market, as it rapidly evolved, is by any measure the right size. Clearing houses could be viewed as the plumbers of the financial system, or the maids who clean up after unruly banks or stand-ins for central banks, but mandatory clearing of derivatives was one of the "big wins" in the reform process, Stanley said.
Over the past decade, the global derivatives market, in the years prior to the financial crisis "went vertical" on the charts as it exploded with growth and "the risk exposure of these markets blew up over a very short time period". In just one six-month period, the derivatives market's overall size grew by $13 billion, and when both sides of transactions are netted, the exposure "spikes by 30 per cent to over a trillion dollars". Credit derivatives alone played "a major, major part in the financial crisis", Stanley said.
In future periods of financial stress, the liquidity and capital demands "are going to present a systemic threat", he added. Either there will be large capital buffers all the time or there will be demands during stress periods that will add to whatever crisis is underway, a "pro-cyclical" factor that can add to risk at the same time "markets are going to be moving around". Even with "strong and forceful regulation", he said, "we're going to have some real tail risks that remain and regulators have to be willing to increase the costs of the derivatives market, the costs of transacting in derivatives, in order to reduce those tail risks". Clearing house regulation will have to be integrated with bank regulation "because those risks can be returned to the banks".
Further reporting © MNI Deutsche Börse Group