Are the CCPs’ powers too wide-ranging?

A comprehensive and clear definition of Central Counterparties is proposed by the European Commission stating that ‘a CCP is an entity that interposes itself between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer. Due to its central role in the market, a CCP normally bears no market risk (the latter is still borne by the original parties to the trade)’ 

The concerns evidenced during recent financial crises have boosted the need for an extensive and well-founded regulatory framework for the CCPs. Nevertheless, the risk to create new too big to fail institutions must be seriously considered by regulators. Thus, regulation and supervision of Central Counterparties must preserve the nature of these entities as Financial Market Infrastructures that enable better management of risk instead of creating risks themselves. The warning comes from the increase of the scale and importance of CCPs for the functioning of the financial system, inspired by the G20 commitments on reforming OTC derivatives.

Following this rationale the Bank for International Settlements and the International Organisation of Securities Commissions (IOSCO), an umbrella group of regulators, have called for the drafting of a recovery plan. In a report published last month the regulators said CCPs should be given the tools to “continue to provide critical services as expected, even in times of extreme stress”.

Regulators included the option for CCPs to tear up derivatives contracts or apply a “haircut” to margins. The report also said clearing houses should be able to allocate any uncovered losses to their members and to replenish any funds they had used after a “stress event”.

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FT Article 15th Oct 2014