CCP Recovery and Resolution Regulation will improve financial stability | Wolters Kluwer Financial Services
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  • CCP Recovery and Resolution Regulation will improve financial stability

    By Michael Imeson

    Published February 15, 2017

    New EU rules will make it easier for the authorities to save CCPs if they get into difficulties, or wind them down in an orderly way if they fail, writes Michael Imeson.

    The European Commission has proposed a Recovery and Resolution Regulation for central counterparties (CCPs) – essential market infrastructures in the financial system – to ensure they can be dealt with quickly and effectively if they get into trouble. The CCP Recovery and Resolution Regulation, proposed in November 2016, is now being reviewed by the European Parliament and Council of the EU. It should be adopted by them by the middle of 2017 and come into effect in late 2017 or early 2018.


    A CCP, also known as a “CCP clearing house”, or just “clearing house”, is an intermediary between buyers and sellers of shares, bonds, derivatives and other financial market instruments. Its members are banks, broker-dealers and specialist commodity houses. The CCP guarantees the contractual obligations agreed between the buying and selling counterparties. The buyer’s obligation is to make the payment, and the seller’s obligation is to deliver the financial instrument. If one counterparty fails to meet its obligations, the other is protected by the default management procedures and resources of the CCP. CCPs are therefore vital market infrastructures performing services designed to reduce risk in the overall financial system.


    But what if the CCP itself gets into financial or operational difficulties? How would that affect the trading counterparties, and the wider market? High standards for CCPs already exist under the European Market Infrastructure Regulation (EMIR), but there are no EU-wide rules for dealing with CCPs that face severe stress or fail and that need to be recovered or resolved in an orderly manner.


    The value of trades handled by CCPs around the world has nearly doubled since the G20’s commitment after the 2007-8 financial crisis to clear standardised OTC derivatives through CCPs. The European Commission therefore decided that measures should be put in place to safeguard this important part of the financial systems. The proposed Regulation, which Europe’s 17 CCPs are fully behind, will create a recovery and resolution framework for CCPs similar to that for banks set out in the Bank Recovery and Resolution Directive (BRRD), and is based on international guidance from the G20, the Financial Stability Board (FSB), the Committee on Payment and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO).

    Key features

    The Regulation’s key features are as follows:

    • Recovery plans – CCPs will have to draw up recovery plans which include measures to deal with any form of financial distress that could exceed their default management resources and other requirements under EMIR. Such distress scenarios should include defaults by CCP clearing members, fraud, cyber attacks and other operational risks. The recovery plans have to be approved by the CCP’s supervisor.
    • Resolution plans – the relevant financial authorities in each country – such as the financial regulator/supervisor, central bank or finance ministry – will draw up resolution plans for how to “resolve” CCPs if they fail. These plans include how to restructure and maintain the critical functions of a failed CCP. A CCP will be placed in resolution when it is failing, or likely to fail, and if no private sector alternative can avert its failure.
    • Resolution colleges – resolution colleges for each CCP will be created, made up of national supervisors and other relevant authorities such as the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA). The colleges will ensure close cooperation between the authorities on resolution planning.
    • Early intervention by supervisors – CCP supervisors will be given powers to intervene in the operations of CCPs when they get into trouble but before they fail. Such powers could include requiring the CCP to take specific action under its recovery plan, or make changes to its business strategy or legal or operational structure.
    • Resolution tools – if a CCP does fail, the authorities will have several “tools” to resolve it. These include the “sale of business tool”, whereby the authorities would sell all or part of a CCP to another entity; a “bridge CCP tool”, which identifies essential functions of a CCP and puts them into a new CCP (“bridge CCP”) which could be eventually sold to another entity, while the old CCP with the remaining functions is then liquidated; and a “position allocation tool”, which aims to re-match the CCP’s book.

    “This proposal will strengthen Europe's financial system further and aims at protecting taxpayers by ensuring we can deal with a central counterparty if it falls into difficulty,” says Commission Vice-President Valdis Dombrovskis, responsible for Financial Stability, Financial Services and Capital Markets Union. “That's important because central counterparties are a critical part our financial system, helping businesses manage their risks. It will complement the stronger regulation of derivatives markets that we put in place after the crisis". 


    The European Commission says that once the Regulation has been adopted by the Parliament and Council it will take effect at the same time as the amendments to the BRRD take effect, which is supposed to be 1 July 2017. However, in reality there are so many discussions needed between the European Commission, CCPs and the relevant public authorities in all member states that it is unofficially accepted that the so-called “level 1 framework principles” of the Regulation will probably not be finalised and applied until the end of 2017 or early 2018.

    Furthermore, many provisions in the Regulation will require “level 2 detailed technical standards” before they can be applied. They will have to be drawn up by the European Securities and Markets Authority (ESMA) and agreed by the Commission, and will therefore not apply until late 2018 or 2019.

    What the CCPs think

    Rafael Plata, Secretary General of the European Association of CCP Clearing Houses (EACH), based in Brussels, believes the proposed Regulation is a good one. There are three main reasons for this he says.

    “Firstly, the authorities would only intervene to resolve a CCP in an extreme situation, a worst-case scenario, if more than the two of its largest clearing members failed at the same time,” says Mr Plata.

    “The second reason is that the Regulation balances predictability and flexibility. You need predictability because you want to ensure that the authorities dealing with a resolution have the right tools to address it, and as many tools as possible to hand. The Commission’s proposal ensures this. Yet at the same time, the proposal leaves enough flexibility to the resolution authorities to use those tools in different ways depending on the specific situation. It’s an approach called ‘constrained flexibility’, which balances predictability and flexibility.

    “The third reason we support the Regulation is that it is aligned with international standards on crisis management for CCPs set by the Financial Stability Board, CPMI and IOSCO. It’s very important that in an extreme scenario all the CCPs’ authorities around the world deal with it in a similar and co-ordinated way.”


    The Regulation is therefore unlikely to be controversial. But when discussions start some issues may start to “pop up here and there”, says Mr Plata. “For example, the proposal needs to make sure that the incentive structure on which CCPs are based is not damaged.”

    By “incentive structure” he means the way in which a CCP guarantees a transaction. Essentially, this consists of calculating the open positions in a transaction, then transforming those positions into the financial resources the CCP needs from the clearing members in case anything goes wrong.

    “Those resources are calibrated to make sure that the CCP performs good risk management, and that the clearing members and their clients do not bring undue risk into the CCP or try to ‘game’ the CCP. We need to make sure that any potential amendments to the Commission proposal do not damage this incentive structure because it is the core of the CCP. It is a mutualised risk management system where the different users of the service depend on each other.”

    A spokeswoman for LCH, the CCP owned by the London Stock Exchange, said its position on EU plans for CCP recovery and resolution legislation had not changed since it set out its position in a white paper earlier in 2016, and it agrees with what is being done. The white paper, entitled Recovery & Resolution: A Framework for CCPs, states: “LCH fully supports the continued efforts of CPMI-IOSCO, Financial Stability Board (FSB) and policymakers around the world to create a regulatory framework that will further enhance the resiliency of central counterparties (CCPs).”

    However, LCH makes the point that CCPs are already safer than they were, even before the new Regulation. This is because the BRRD, which came into operation in January 2016, has made the banks using CCPs safer. With CCP member banks themselves now subject to recovery and resolution schemes, LCH says this “materially reduces the risk of, and the potential scale of, a member default”.

    About the author: Michael Imeson Chartered MCSI is Contributing Editor of The Banker magazine; Senior Content Editor at Financial Times Live where his role is to organise and/or chair events on financial services; and the owner of editorial services agency Financial & Business Publication. Michael is also a regular contributor to Wolters Kluwer’s Compliance Resource Network.

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