Initial margin must remain the most important defence for central counterparties (CCPs), while stress-testing and transparency of results is the key to increasing confidence in them, according to a whitepaper from LCH.Clearnet.
The report generally praised the post-crisis regulatory reforms for strengthening the resilience of the financial system, but stressed that the risks facing CCPs are different to those facing banks and other institutions, and should be approached differently.
The paper outlined Clearnet’s planned approach to the three areas subject to debate; risk management, recovery and resolution.
It said that CCPs should have the appropriate recovery tools and margins available to deal with a clearing member default, and that a recovery plan should be developed in consultation with both clearing members and clients.
This is part of a plan to keep procedures transparent, predictable and accessible for all parties involved.
According to the whitepaper, the CCP should also cap the additional cash contributions it can take from a surviving clearing member in the case of a default, and any net recoveries from the default should be used to reimburse the surviving party.
With regards to risk management, it pointed out that the Principles for Financial Market Infrastructure requires a 99 percent minimum confidence level for all products, and the European Market Infrastructure Regulations (EMIR) require 99.5 percent. Clearnet plans to self-impose a 99.7 percent minimum confidence level, thereby surpassing the regulatory minimum.
Clearnet also supports mandatory stress-testing, and suggested that global coordination may be required to make this a possibility.
Resolutions will be more effective if they are led by the authority of the jurisdiction in which the CCP is established. Clearnet said it will welcome guidance from the financial stability board, and encourages the formation of crisis management groups, formed of supervisors, financial groups and public authorities.
The measures outlined in the whitepaper come as the latest development in the debate surrounding the role of CCPs and their stability.
EMIR recently mandated CCPs for all over-the-counter derivatives trades, however some institutions have questioned the sustainability of CCPs, and warned of the dangers of a CCP failing.
The European Securities and Markets Authority (ESMA) chief Steven Maijoor called for a recovery and resolution framework for CCPs in November, saying: “While it is difficult to compare CCPs with banks, as their business models are fundamentally different, it is clear that the systemic impact of a failure of a large CCP would equal, or even exceed, the systemic impact of the failure of a large international bank.”
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