Article first published in FT Trading Room on 17 February 2015
During the financial crisis, public support for the financial industry was administered on enormous scale. For a clear reason: the external costs of major firms’ failures were presumed to be too extreme. On one hand, there was no real plan how to deal with problems at large, complex firms. On the other, the opacity of firms’ interconnections exacerbated that uncertainty: it was unclear how losses would affect their clients and counterparties. Plans for banks’ own recovery and resolution (RRP) is now a legal requirement.
The new regulatory regime also broadens the use of clearing houses, also known as central counterparties (CCPs), to create strong independent risk management and de-link market participants. The mainstay of a CCP is collecting collateral up-front from its members, e.g. banks, to cover potential losses should it need to liquidate open trades after a default of a member. The CCP is made extra safe through a mutual pot provided by all its members, should the defaulter’s collateral prove insufficient.
The full article is available on Eurex Clearing’s website here.