Beyond a 'One-Size-Fits All' Approach to Central Clearing

How can central counterparty clearing houses (CCPs) reduce systemic risk and avoid the ‘too big to fail’ (TBTF) stigma? In a new paper, the World Federal of Exchanges (WFE) suggests that safe, efficient, and orderly markets will only come from acknowledging that firms and markets are varied and that each organization has specific risk management procedures, systemic insight, and institutional knowledge that must be factored into the clearing process. 

Appropriate CCP transparency and disclosures: Disclosure is valuable to regulators and for market participants to ease exposures, but CCPs should not be required to supply overly-specific information that allows a competitor to gain an edge and reduce stability of the overall market.

Following are highlights from its recent statement: 

• Market practices: WFE supports the effort by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) to formalize industry procedures for CCP rulebooks, Internet sites and transparency of disclosure statements. 
• Margin requirements: CCPs should allow for tools so that their margin requirements can be replicated, but WFE believes that they are in the position to judge what margins work best for them.
• Defaults: Standards for default management should be clearly outlined but overly narrow rules may limit how effectively a CCP can respond to a problem.
• Emergency powers: Considerations of control during times of distress should recognize the distinction between a CCP and its participants, how flexibility is essential to effective management, and that emergency powers are crucial in dynamic markets given how rapidly conditions can change. WFE also notes having emergency powers supports the objective of CCP and market continuity.
• Clearing of complex products: CCPs should only clear products when it aligns with their risk management procedures. Regulators have large incentives to ensure clearing is mandated only when appropriate.
• Skin-in-the-game: CCPs and their financial resources such as margin, guaranty fund asserts, and capital have an incentive to maintain suitable risk management procedures. If regulators require standardized contributions that are disproportionate to the risk involved, it could encourage CCPs to take on risk subsidized by others.
• Liquidity: WFE supports access to central bank liquidity and deposit facilities as each CCP requests it. However, it believes diversification of funding is also necessary and worthwhile since it promotes stability and continuity, and that if it comes from clearing members and affiliates, it promotes “skin-in-the-game.”

Given that central clearing advances the Group of 20 (G20) post-financial crisis regulatory objectives, the report notes that it is imperative to enable its expansion. Doing so requires that each CCP has the proper risk management and default procedures in place. 

To read the full paper, click here.