INTERNATIONAL: ISDA Comment on CCP Resolution

Tuesday August 16 2016

The Financial Stability Board (FSB) has reiterated its intention to prioritise central counterparty (CCP) resilience, recovery and resolution for the remainder of 2016. Several clearing houses have become systemically important as a result of global clearing mandates, and it’s vital this infrastructure is as secure as possible. This can potentially be achieved by establishing a credible and robust recovery and resolution framework.

Considerable thought has gone into this issue at both the regulatory and industry level over the past few years and International Swaps & Derivatives Association (ISDA) has published several papers on the issue (click here for the most recent ISDA papers). An important recent consideration has been when and how recovery becomes resolution, in other words, at what point should resolution authorities step in, and what tools will be available to them?

ISDA recognises that there may be situations where a resolution authority has to intervene before CCP-led recovery efforts have fully run their course. That might include circumstances where it is felt the recovery measures set out in the CCP rule book would further increase systemic risk or lead to contagion. But, if resolution authorities elect to enter a CCP into resolution, it is important to abide by certain conditions to maximize certainty and predictability and maintain market confidence.

In particular it is important that resolution authorities, should they intervene, follow the rules and the tools defined in the CCP rule book. ISDA has already set out a proposed recovery framework, which includes a variety of loss-allocation and position-allocation tools and the sequence of their use, aimed at providing maximum predictability of outcomes. This framework is recommended by the ISDA to be adopted in CCP rule books, approved by regulators and followed by resolution authorities. By following this transparent rule book, a resolution authority may provide comfort to market participants and minimise market disruption, as well as ensuring the concept of ‘no credit worse off’, a central element of the ISDA recovery framework, is applied.

ISDA also believes recovery should be CCP-led as far as possible, but if that is not possible, the indicators for a resolution authority intervention should be defined upfront.

ISDA also believes that further consideration should be given to whether, through recovery or resolution, clearing participants should be compensated for any losses incurred through loss-allocation or position-allocation tools, over and above the CCP’s funded and unfunded default resources. This reflects the outcome that would be achieved if clearing participants were to go through an insolvency process.

Ensuring CCPs are initially strong minimises the prospect of a recovery or resolution action. Transparency, stress testing, monitoring of concentration risk and scrutiny of suitability of products for clearing are all important in this regard

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