There is little way to avoid the fact that central counterparties (CCPs) are the new Too Big To Fail institutions in financial markets, and that a large CCP failure would cause untold harm to economies worldwide. A new report from Finadium reviews the many plans and proposals now in discussion to mitigate the risk of a CCP failure.
This report is a review and analysis of proposals for CCP recovery and resolution plans. CCP clearing members and end-users across all products are aware that CCPs look strong from the outside and stress tests like Cover 2 seem important. However, CCPs can only withstand so much turbulence before their reserves are depleted. In the event of a major crisis with multiple bank failures, CCPs may lose their lines of credit or other “guaranteed” backstops. What happens then?
Regulations have explicitly supported the build-up of mutualized risk at CCPs but have left possible holes in their policies should a CCP fail. Now, market participants, CCPs, governments and academics are all working to figure out what happens at the end of a CCPʼs risk waterfall. The subject is relevant across financial markets and has particular importance for securities finance participants evaluating securities lending and repo CCPs.
While market thinking currently leans towards recovery, the resolution side of the argument should be addressed nonetheless. Understanding what types of risks a CCP may offer in a worst-case scenario is an important part of evaluating the use of CCPs in the first place.
This report has been written for financial market participants that seek a grounded understanding of the policies and proposals of CCP resolution plans in plain English. We summarize the main views and provide detailed examples while attempting to minimize the in-depth back and forth of each sub-argument and specifics. The result is a robust overview of the main players, regulations and ideas in the CCP recovery vs. resolution debate.
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