Regulation and Supervision of the OTC Derivatives Market by Ligia Catherine Arias-Barrera

Author:Ligia Catherine Arias-Barrera
Language: eng
Format: epub
Publisher: Taylor & Francis (CAM)
Published: 2018-04-13T16:00:00+00:00

4.3.2 Features of CCPs’ insolvency regime

In the area of the insolvency of SIFIs, the most recent discussions come from the failure of Lehman Brothers.138 Although Lehman is not a CCP, it is a case that demonstrates some common features affecting SIFIs in financial distress139 in the OTCDM,140 and from which regulators might draw some lessons. In the event of SIFI insolvency, it must be possible to stabilise the existent contracts effectively.141 Hence, the SRR should allow the resolution authority to market the contracts of the portfolio at their fundamental value; note that this is different to the fire sale prices. Moreover, it is also recommended that the resolution authority hold the entire portfolio together and sell it along its product lines,142 which is challenging due to the large size of such portfolios. Particularly in the case of CCPs,143 the authorisation for sales along product lines is a good place to start.144 The rationale is to structure the insolvency regime to close out and liquidate positions in such a way that the portfolio is coherently sold when possible.

The design of an SRR should address some basic questions concerning how to efficiently allocate losses, how to mitigate fire sales,145 and how to ensure the continuity of the clearing services.146 In this regard, the industry shares the concern of the consequences of a CCP failure and has advised certain elements that a CCP resolution plan should include. In particular, JP Morgan147 emphasises the importance that a resolution regime for CCPs effectively limits contagion, avoids pro-cyclicality,148 and ensures the continuity of services. The first recommendation is that regulators design a credible recapitalisation strategy that seeks to favour recapitalisation over liquidation. The benefits of recapitalisation include the reduction of fire sale risk on collateral and preventing the creation of potential asymmetry of risk across participants, which in turn results in extreme volatility.

In the opinion of JP Morgan, the current framework of loss allocation in cases of clearing members’ default is inefficient, hence the need for regulators to design a recapitalisation strategy. The shortcoming of the loss-allocation rules could be overcome by implementing standard stress tests; EMIR mandates CCPs to conduct stress tests, but at the same time foresees that CCPs apply different sets of stress tests in order to ensure safe and sound risk management.149 The Bank has not designed a standard stress test, but to guide the bespoke stress tests developed by each CCP.150 Therefore, although the international bodies will propose some minimum elements of CCPs’ stress tests151 that will be necessarily followed by the Bank, it has not included the standardisation of these tests within its regulatory priorities. Although the adoption of standardised stress tests is debated, there have been some private initiatives152 proposing best practices CCP should observe when conducting stress tests and, in that way, achieve a certain level of standardisation. The objective of the European CCPs’ initiative in this matter is to clarify the meaning of ‘extreme-but-plausible market conditions’ – the parameter referred to in EMIR when conducting stress tests. In

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