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LONDON, Feb 7 (IFR) - The World Federation of Exchanges has urged lawmakers to ensure that authorities tasked with the orderly wind-down of failed clearinghouses only invoke resolution proceedings as a last resort.
The industry association, which represents over 200 market infrastructure providers including more than 100 central counterparties and central securities depositories, noted in a white paper on the interplay between CCP recovery and resolution that cross-border cooperation is vital to ensure orderly markets and has called for regional and national authorities to align as closely as possible to international standards.
The point at which a failing CCP's own recovery efforts turn into a resolution situation has become a point of intense debate, stoked by a recent consultative document from the Financial Stability Board and draft legislation from the European Commission published late last year.
EC proposals deliberately lacked prescriptive detail over the point at which authorities can step into a CCP recovery and invoke resolution proceedings. The broad language reflects an attempt to prevent market participants from exacerbating a stress scenario by taking action that would make the CCP's failure self-fulfilling.
The WFE paper, which reflects a consensus view of the exchange industry, calls for greater clarity over the inflexion point and warns that resolution proceedings should only be invoked once all recovery measures, as defined in the CCP's rulebook, have been exhausted, or if ongoing execution of the recovery plan would create systemic stress in broader financial markets.
"While acknowledging the need for clear resolution plans, there needs to be clarity as to when they should be invoked. There also needs to be flexibility as to how resolution plans are executed in the interests of the wider markets and stakeholders," said Nandini Sukumar, CEO of the WFE.
The trade body notes that resolution authorities should only step in where it is clear that recovery is not, or will not be successful. The relevant resolution procedures should be defined in advance and established under relevant law or regulation, the WFE says.
"The uncertainty as to whether, when and to what extent an earlier intervention may take place will inevitably inject yet more uncertainty into an already complex situation," the white paper says.
According to the WFE, a CCP placed into resolution too early would thwart a successful market-driven recovery and create inefficiencies in the market, leading to imbalanced losses among users. Similarly, a CCP placed into resolution too late could reduce the effectiveness of resolution actions as financial resources could be consumed by a failed recovery situation.
In addition, the WFE warns that member incentives to ensure the success of recovery tools could be damaged by an incorrect determination of the point of resolution, as members could be incentivised to embark on actions that could trigger a resolution.
"We therefore consider it vital to strike the right balance between providing sufficient certainty to participants (including the CCP) and leaving the authorities with enough flexibility - bearing in mind the significant risks which would be created by early entry - to make the correct decision to preserve and protect market stability," the WFE paper says.
CCPs have become focal points of risk as a result of new rules that have pushed around 60% of the US$544trn over-the-counter derivatives market into central clearing. WFE has supported initiatives by CPMI-IOSCO and the FSB to create international standards for CCP risk management.
In a call for greater cross-border cooperation arrangements, the WFE also supports simulated exercises to be performed by relevant authorities to ensure fast action and decision making in a live market event.
It also notes that the resolution of a CCP should be led by the resolution authority of the jurisdiction in which the CCP is established, and done in close consultation with the home supervisory and prudential regulators to ensure appropriate information and decision making.
The WFE intends to respond separately to the FSB consultation before the March 13 deadline.
"We are encouraged by the ongoing alignment and consistency of international standards between key market stakeholders," said Gavin Hill, head of regulatory affairs at the WFE. "The WFE will sustain its global advocacy mandate on post-trade issues to ensure the perspectives of the exchange and CCP sector continue to be heard." (Reporting by Helen Bartholomew; Editing by Ian Edmondson)