A CCP acts as the intermediary to both sides of a transaction in a financial instrument, including bonds, equities, derivatives andcommodities (such as agricultural products, oil and natural gas). They are critical in helping to reduce risks and interconnections through the financial system. They help financial firms and end users such as corporates manage their business risks. The scale and importance of CCPs in Europe and globally has nearly doubled since the post-crisis G20 commitment to clear standardised over-the-counter (OTC) derivatives through CCPs. A large proportion of the EUR 500 trillion of derivatives contracts that are outstanding globally are cleared by 17 CCPs across Europe.
There are already high regulatory standards in place for EU CCPs, set out in the European Market Infrastructure Regulation ("EMIR", see MEMO/12/232). However, no EU wide rules are in place for the unlikely scenario where CCPs face severe distress or failure and therefore need to be recovered or resolved in an orderly manner. Today's proposal aims to put into place a recovery and resolution framework to CCPs which are systemically important for the financial system. This will ensure that the critical functions of CCPs are preserved while maintaining financial stability and helping to avoid the costs associated with the restructuring and the resolution of failing CCPs from falling on taxpayers.
Vice-President Valdis Dombrovskis, responsible for Financial Stability, Financial Services and Capital Markets Union, said: "This proposal will strengthen Europe's financial system further and aims at protecting taxpayers by ensuring we can deal with a Central Counterparty if it falls into difficulty. That's important because Central Counterparties are a critical part our financial system, helping businesses manage their risks. It will complement the stronger regulation of derivatives markets that we put in place after the crisis".
Vice-President Jyrki Katainen, responsible for Jobs, Growth, Investment and Competitiveness, said: "Central Counterparties work across borders and are critical in helping to reduce risks throughout the financial system. Nevertheless, we must be prepared for the event – however low the probability – of a failure of a CCP and have the necessary rules in place. Today's proposal is important in securing confidence in our financial system."
The financial crisis clearly illustrated that the failure of an important financial institution can cause critical problems for the rest of the financial system and can negatively impact growth across the wider economy. It is important that authorities in Europe have the powers to step in were a CCP to fail, and deal with it in an orderly manner.
Key elements of the proposal
The proposed rules for CCPs set out provisions comparable to those in the recovery and resolution rules for banks (Bank Recovery and Resolution Directive– BRRD) and are based on international standards. However, as CCPs are very different businesses to banks, this proposal contains CCP-specific tools that better align with CCPs' default management procedures and operating rules, especially to determine how losses would be shared.
The proposed rules require CCPs and authorities to prepare for problems occurring, intervene early to avert a problem, and step in when things have gone wrong.
Preparation and prevention
The proposed rules require CCPs to draw up recovery plans which would include measures to overcome any form of financial distress which would exceed their default management resources and other requirements under EMIR. This should include scenarios involving defaults by clearing members of the CCP as well as the materialisation of other risks and losses for the CCP itself, such as fraud or cyberattacks. Recovery plans are to be reviewed by the CCP's supervisor.
Authorities responsible for resolving CCPs (i.e. resolution authorities) are required to prepare resolution plans for how CCPs would be restructured and their critical functions maintained in the unlikely event of their failure.
Early intervention will ensure that financial difficulties are addressed as soon as they arise and problems can be averted. CCP supervisors are granted specific powers to intervene in the operations of CCPs where their viability is at risk but before they reach the point of failure or where their actions may be detrimental to overall financial stability. Supervisors could also require the CCP to undertake specific actions in its recovery plan or to make changes to its business strategy or legal or operational structure.
Resolution powers and tools
In line with the guidance of the Financial Stability Board, a CCP will be placed in resolution when it is failing or likely to fail, when no private sector alternative can avert failure, and when its failure would jeopardise the public interest and financial stability. In addition, it could be placed into resolution where the use of further recovery measures could compromise financial stability even when the conditions above are not met.
Cooperation between national authorities
CCPs are cross border in nature, with the biggest CCPs operating internationally. It is important that authorities cooperate across borders to ensure effective planning and orderly resolution if needed. The proposal establishes so-called resolution colleges for each CCP containing all the relevant authorities including the European Securities and Markets Authority (ESMA) and the European banking Authority (EBA).
The existing colleges under EMIR and the newly set-up resolution colleges should jointly undertake the specific tasks allocated to them under this Regulation. ESMA will facilitate joint actions and act as a binding mediator if necessary.
The draft Regulation will now be submitted to the European Parliament and the Council of the EU for their approval and adoption.
A public consultation on a possible recovery and resolution framework for non-bank institutions was carried out by the European Commission between 5 October and 28 December 2012. It inquired about the need for recovery and resolution arrangements mainly in relation to CCPs, central securities depositories and insurance undertakings. On the whole, the consultation indicated that the priority should be to develop EU-wide recovery and resolution rules for CCPs. The implementation of the G20 requirement for standardised OTC derivatives to be centrally cleared was recognised as a compelling argument in favour of taking action.
At the international level, G20 leaders have endorsed the approach developed by the Financial Stability Board (FSB) to address the risks which the failure of any financial institution (bank, financial market infrastructure, insurance undertaking, etc.) of global systemic relevance could have on the financial system via comprehensive and appropriate recovery and resolution tools. Furthermore, the Committee on Payment and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO) have developed guidance on recovery plans for financial-market infrastructures, including CCPs, while the FSB has issued further guidance on the application of its Key Attributes of Effective Resolution Regimes to financial market infrastructures such as CCPs. This guidance has been reflected in the Commission's proposal.
Wider work on resolution
The analysis for the need to respond to the possible recovery and resolution of other financial firms than banks and CCPs is still underway. This is mainly due to the lessons learned during the financial crisis which did not demonstrate an equally urgent need for such measures. However such measures may be necessary in the future, taking account of the development of economic and financial risk in the sectors concerned.
Wider international work on insurance undertakings at G20-level is in its relatively early stages. Within Europe, the European Insurance and Occupational Pensions Authority (EIOPA) has engaged in a thorough, comparative and wide-ranging review of national recovery and resolution practices and developments in this area and is set to present a report on this topic in the first half of 2017. On the basis of that report, the Commission will consider the appropriate way forward, in close consultation with the European Parliament, Council and all relevant stakeholders.
In 2015, on average more than 50% of the USD 493 trillion global market in OTC derivatives was centrally cleared by CCPs.This almost doubles the percentage from when the G20 commitment was made in 2009. On average, 70% of all new OTC derivatives transactions could now be cleared.
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