The global regulatory system is widely seen to be much safer now than it was during the global financial crisis.

Regulators around the world have demanded more capital, more collateral and more clearing. And to a large degree they now have what they wanted.

“We have progressed dramatically since 2008,” says Patrick Pearson, Head of Unit of Financial Markets Infrastructure at the European Commission in Brussels. “The global financial system is a lot safer especially with more collateral in the system and more trades being cleared.”

And yet despite the huge efforts undertaken by market participants there are still two major concerns. The first is that financial regulations from different jurisdictions are not fully aligned with one another. And secondly that the risks in the financial systems have been concentrated into central clearing counterparties (CCPs). These two issues come together in the upcoming regulatory push to devise resolution and recovery regime for CCPs around the world.

The simple fact is that different countries have different political agendas, and this ends up being reflected in the differing regulations they promulgate. “We do not have a global legislature and also we do not have a global regulator” says Pearson at the European Commission. “We have created global standards, but these have to be implemented in local markets.”

"We have created global standards, but these have to be implemented in local markets."


For market practitioners operating around the world, it can be frustrating. Compliance with differing sets of regulations on the same market practices can be difficult at best and impossible at worst. Panellists at Euroclear’s Collateral Conference agreed that strong regulations are necessary and benefit the financial markets, especially when there is strong alignment of interest between investors and well-regulated markets. What is also necessary is coherency and consistency in the market structure, especially on market finance and capital.

Focus on CCPs

With this in mind, the EU’s push to create a recovery and resolution regime for CCPs highlights how this process unfolds. Creating this new regime has pitted different EU countries against each other, with differences between larger and small states over who gets to administer the so-called resolution colleges. But it has also created tensions between the clearing houses themselves and their clearing bank and asset manager members, as to who should pay what in the event of a collapse of these critical market infrastructures.

The final Council version of the EU’s proposed regulation is expected to be released in the middle of 2020, bringing these differences out into the open. “The recovery and resolution of CCPs have moved on a lot in the last three months” admits Pearson. “But it is an incredibly difficult dance between the triptych of CCPs, their members and their clients. But, for the EU-institutions, the redline is that if a CCP fails, then the taxpayer will not be expected to pay.”

In whatever way the final text is balanced, it does not detract from the fact that risk is now heavily focused within these institutions. One of the Euroclear panellists suggested that there is resistance to the ever-increasing march toward central clearing as it is a risk management function, and functions do occasionally fail.

Indeed, just because CCPs have not failed in the past, there is nothing to say that there will not be a CCP crisis in the future. Panellists were concerned that with the small capital base CCPs currently have, any recovery and resolution of a failing CCP will involve direct clearing members standing up to support them through a number of difficult actions for the firms involved. 

"If a large CCP is in trouble because of its members default, then we will be having a banking crisis"


CCPs maintain that their capital is appropriately sized, and according to Tony Baldwin, Deputy Head of Collateral and Liquidity Management at LCH, this capital base should not become a loss absorption mechanism. “In the event of a default, risk should be borne by the members, who act as ‘risk takers’, rather than the CCP which is responsible for managing that risk” he said at the conference.

One of the key requirements of the draft paper will be a requirement for the CCPs to undertake scenario planning. And for a CCP to fail, it will likely have been triggered by the simultaneous default of two major members. “If a large CCP is in trouble because of its members default, then we will be having a banking crisis” says Benoît Gourisse, Senior Director, European Public Policy at ISDA. “And even if everyone agrees that taxpayers’ money must be protected, no one can tell for sure how public authorities might react in a serious banking crisis.”

One other potential scenario could be that different regulations over CCPs in different jurisdictions create huge incentives for the reallocation of capital and or business. Such differences of implementation are already emerging with the original regulation that increased the role of the CCPs, namely UMR.

With the successful passage of phases 1 to 4 complete and the market focusing on the challenges of the wider roll out to asset managements in phases 5 and 6, some market participants fear that misalignment in the implementation of these regulations are already emerging. “It has been a huge legal exercise, and although phases 1 to 4 were successful, gaps have already appeared in the way that different countries are regulating UMR, in areas such as scope of products subject to margin, eligible collateral calculations, margin model approval and in areas of settlement timing,” Gourisse at ISDA. “It requires a significant fine tuning.”

A solution to these problems of misalignment is sequencing, namely the informal agreements between different regulatory bodies over which regulators take the lead in which areas, allowing others to then follow their lead. This allows those regulators with the most interest in particular areas to effectively set the agenda.

With the recovery and resolution regime for CCPs, the agenda is being led by the EU. This is in line with its five focus areas of reporting, clearing, capital, trading and margining. “Sometimes Europe is behind and sometimes it is ahead,” says Gourisse at ISDA. “But Europe has delivered, and it has been very consistent.” Market participants are hoping that this will be extended into the new regime covering CCPs.

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