European Association of CCP Clearing Houses (EACH) pushes back on clearing member compensation guidance

The European Association of CCP Clearing Houses (EACH) welcomes the opportunity to respond to the FSB consultative document “Guidance on financial resources to support CCP resolution and on the treatment of CCP equity in resolution”. In summary:

  • Compensating clearing members beyond the CCP rulebook may endanger taxpayers’ money – Compensating clearing members for their losses borne in excess of the rulebook may likely result in clearing members suing the resolution authority. Such a provision creates a new route for compensation without the protection of the No Creditor Worse Off than in Liquidation (NCWOL) safeguard, whereby any deviation from the resolution authority beyond the CCP’s rulebook would expose it to claims via the CCP (as it takes over the CCP in resolution). As there is no limit on the amount of ‘financial resources in excess of the rulebook’, nor the possibility to write them down, the resolution authority would be exposed to potentially unlimited claims from the clearing members. In addition, it creates the unintended consequence of incentivising members to shorten the rulebook to receive compensation in order to limit the ‘sunken costs’ of recovery.
  • Non-Default Losses and the “polluter pays” principle – We believe that each stakeholder involved in a non-default loss should be responsible for it unless other arrangements are indicated in the CCP rulebook. This would ensure an allocation of the non-default loss that is proportional to the level of responsibility and/or benefits extracted from a service of each stakeholder, including CCP owner or CCP user.
  • Increasing the CCP equity is not always the answer – A CCP should have enough resources at stake to ensure that it is incentivised to deliver adequate risk management, and this is performed through the CCP’s own contribution: the ‘skin-in-the-game’. Requiring CCPs to prefund an amount which creates meaningful loss absorbency for excessive member losses would create moral hazard, as the CCP would pay for the risks taken by its members.
  • CCP shareholders are always exposed to losses – We would like to suggest the FSB to take into consideration that, in some jurisdictions like the EU, CCP shareholders are always exposed and therefore will always bear losses, either in resolution or as a result of the liquidation of the CCP in case of insolvency. In practice, this would mean that the NCWOL counterfactual should reflect the economic costs of closing down a CCP, in addition to that of applying the rulebook. In particular, in case of resolution authority intervention, the potential for CCP shareholders to exercise claims against the resolution authority is minimised, as the NCWOL counterfactual would always include the dilution of the CCP shareholders’ equity, they are last in line in normal insolvency proceedings.
  • Timing of entry into resolution – We believe resolution authorities should define this timing as follows:

o   Unsuccessful (or clearly will be unsuccessful) recovery – The resolution authority should preferably intervene after the exhaustion of the resources and tools defined for recovery in a CCP’s rulebook and recovery plan. We therefore support the FSB’s existing guidelines on resolution which prescribe that resolution is triggered when ‘the recovery tools failed to return the FMI to viability, have not been implemented in a timely manner, or relevant authorities determine that recovery measures are not likely to return the FMI to viability’.

o   Early intervention – If early intervention occurs, it is critical that the legal responsibility of either the CCP management or the resolution authority is clear at all times to avoid a situation whereby the CCP’s management would find itself only partially independent but legally accountable for the decisions made.

o   Financial stability concerns – The resolution authority should have to demonstrate that there is clear and convincing evidence that entry into resolution prior to the exhaustion of the CCP’s recovery plan would result in greater financial stability (e.g. to avoid a contagion effect across multiple CCPs).

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