London, Wednesday 4 December 2019 – The World Federation of Exchanges ("WFE"), the global industry group for central counterparties (“CCPs”) and exchanges, has said it is starting a 12-month workplan to ensure that the role and nature of CCPs is correctly understood, and is not undermined by narrow interests that diverge from good public policy.
In doing so, the WFE will engage with all stakeholders, while continuing to promote the principles that first made the CCP model the trusted approach to counterparty credit issues. The WFE programme will take a comprehensive, first-principles look at all relevant questions, including the rationale for CCPs in the financial system and society. It will factor in research that has been produced in this area, while avoiding a selective or one-sided approach.
It took a collapsing banking and credit system in 2008 for the wider world to see what some already knew: that there is a major role for neutral, central entities who can enforce discipline on risk takers and, in the process, reduce systemic risk. Ten years on, in close collaboration with supervisors, this is the role that central counterparties continue to perform, requiring those who build up positions to put not just promises but cash (or other collateral) on the table, commensurate with the risk they bring to the system.
This is the primary reason why public policy rightly aims to maximise central clearing. Such an approach to risk enforces discipline, rather than allowing risk-originators to pass on responsibility. It is the reverse of the situation pre-2008, where the perception of a public backstop led to excessive risk taking, in a severe case of ‘moral hazard’. As such, it would be irresponsible and reckless to have any CCP act as the system’s underwriter-of-last-resort. This, however, is a recurring theme in an increasing number of advocacy programmes.
CCPs’ own resources perform an important but entirely distinct role, backing their own operational continuity and signalling their responsibilities to measure and monitor accurately and impartially the degree of risk being taken in the market. CCP resources are not there merely to insure or underwrite risks assumed by others. While commercial tensions can arise in clearing – for example, regarding the balance of liability as between clearing brokers and their customers – other issues around incentives require particular care, in order to avoid jeopardising the public good.
Accordingly, the WFE work will in principle study the risks of changing what is currently a coherent set of incentives that are consistent with systemic safety, including in recovery or resolution. And the analysis will cover the diverse range of so-called ‘non-default losses’, each of which should be analysed as a distinct case and, depending on the type of loss and specific governance arrangements, may be attributable to a CCP, to its members, or even to neither.
Where appropriate and possible, CCPs liaise closely with those taking risk. But a CCP will always be better placed than individual members to see and understand the distribution and concentration of risk in a given market. This is another reason for public-policy to encourage clearing. And, in extreme circumstances, the risk mutualisation that a CCP brings ensures a collective commitment to protecting the system. At the same time, CCP users benefit economically from multilateral netting – as does the system as a whole – ensuring a ‘positive externality’, irrespective of the CCP’s ownership structure.
Discrete policy issues do remain. It has notably become increasingly important to monitor and mitigate the concentration among bank clearing members, which increases risk while reducing access to clearing. At a minimum, more and better public disclosures from such entities (and from large end-users) will be required in future. And banking supervisors will have to be vigilant, because of the potential impact on CCPs around the world of many simultaneous bank failures. Overall, however, the WFE supports the current public-policy framework for CCPs, namely: effective international standards; and supervision of individual CCPs by specialist regulators.
The WFE’s work will seek to analyse and explain the structure and incentives within central clearing. Its objective is to maximise clarity among market participants who benefit from clearing and to help ensure they are prepared to honour all their commitments. The WFE will discuss some of the empirical findings and work to date at IOMA: WFE’s Clearing & Derivatives Conference in March 2020, where the federation will bring together stakeholders on these issues.
Nandini Sukumar, Chief Executive Officer, WFE said: “As the global industry group for CCPs and exchanges, we consider it vital that there is greater understanding around the role of CCPs. CCPs should not simply take on the risk of others; indeed, the global clearing system is one which aims to ensure that the defaulter pays – not the creditor. There is currently much misinformation around the role, responsibility and working of the CCP. We will be working hand-in-hand with all market constituents, to ensure that stakeholders are well-informed on the topic of risk management.”