The EU is stepping up its rules to make clearing houses safer and address systemic risk that could arise from their potential failure.
The Presidency of the Council and the European Parliament today reached a deal on a common set of rules for central counterparties (CCPs) and their authorities to prepare for and deal with financial difficulties. Following finalisation of technical work, the political agreement will be submitted for endorsement by member states’ ambassadors to the EU.
“The current context, characterised by important volatility and uncertainty, reminds us of the vital function clearing houses play to make our financial markets safer. By putting EU rules in place to deal with their potential failure, we are adding an essential piece of legislation to secure confidence in our financial system.”
– Zdravko Maric, Deputy Prime Minister and Minister of finance of Croatia
The proposed rules aim at providing national authorities with adequate tools to manage crises and to handle situations involving failures of key financial market infrastructures. They build on the same principles as the recovery and resolution framework applying to banks.
The main objectives of the reform are:
- to reduce the probability of CCP failure by introducing effective incentives for proper risk management
- in case a financial difficulty would effectively arise, to preserve CCPs’ critical functions, to maintain financial stability, and to prevent taxpayers from bearing the costs associated with their restructuring or resolution.
The new rules will take into account the global and systemic nature of CCPs. They will provide for close coordination between national authorities in the framework of “resolution colleges” in order to ensure that resolution actions are applied in a coherent manner taking into consideration the impact on affected stakeholders and financial stability.
The recovery and resolution will be based on a 3-step approach:
- First, prevention and preparation: CCPs and resolution authorities will be required to draw up recovery and resolution plans on how to handle any form of financial distress which would exceed CCPs existing resources. If resolution authorities identify obstacles to resolvability in the course of the planning process, they can require a CCP to take appropriate measures.
- Second, CCPs can take recovery measures, according to certain viability indicators and based on the prepared recovery plan. These include cash calls to non-defaulting clearing members, the reduction in value of the collateral provided daily to the CCP (so-called variation margin gains haircutting), and the use of the CCP’s own resources. Furthermore, supervisory authorities will have the possibility to intervene at an early stage, i.e. before the problems become critical and the financial situation deteriorates irreparably. For example, they will be able to require the CCP to undertake specific actions in its recovery plan or to make changes to its business strategy or legal or operational structure.
- Finally, in the unlikely case of a CCP failure, national authorities will have the possibility to resort to resolution tools. These include the (partial) termination of the CCP’s contracts, variation margin gains haircutting, the write-down of CCP capital, a cash-call to clearing members, the sale of the CCP or parts of its business or the creation of a bridge CCP. While in certain limited cases, extraordinary public support may be provided as a last resort, the purpose of resolution actions is to minimise the extent to which the cost of a CCP’s failure is borne by taxpayers, while ensuring that shareholders bear an appropriate part of the losses and that taxpayer funds are recouped to the extent possible.
With certain limited exceptions, the new framework will start applying 18 months after the date of entry into force of the regulation to allow time to adopt all implementing measures and for market participants to take the necessary steps to comply with the new rules.
In addition, considering the adverse circumstances arising from the COVID-19 pandemic, the co-legislators agreed that it was appropriate to give one additional year for trading venues and CCPs offering trading and clearing of exchange-traded derivatives to start applying open access rules in MIFIR. The open access regime will therefore only start applying as of 4 July 2021.
CCPs facilitate securities and derivative transactions by centralising and standardising all the steps leading up to payment. They play a critical role in ensuring the stability of financial markets as they take on counterparty risk by stepping in between the seller and the buyer and providing guarantees that the transaction can be completed.
CCPs process important and ever-increasing volumes of derivatives trades every day. At the moment, 13 CCPs are established and authorised in the EU, playing an important part in the global clearing landscape.
Following finalisation of technical work, the text will be submitted to EU ambassadors for endorsement with a view to reaching an agreement in the form of a (pre-negotiated) Council position at first reading. It will then undergo a legal linguistic revision. Parliament and Council will be invited to adopt the proposed regulation pursuant to Article 294(7) TFEU (often referred to as an ‘early second-reading agreement’).