While praising the compromise agreement between the CFTC and the European Commission on cross-border derivatives regulation as evidence that global policymakers are pulling together, Andreas Dombret, the member of the Deutsche Bundesbank Executive Board with oversight of financial stability, cautioned that Dodd-Frank Act and EMIR regulatory requirements could turn central counterparties into “juggernauts” of the international financial system that must be closely monitored. As such, he advised that every central counterparty must have robust risk management structures in place. As competition among central counterparties grows more and more intense, a race to the bottom could ensue as they undercut each other in terms of the size and quality of their margin requirements. Regulators and policymakers must prevent this from happening by, among other things, assuring that the central counterparties’ models for calculating margin requirements are sufficiently conservative.
In the board member’s view, the main problem with central counterparties is that losses could only be distributed among clearing participants, which is usually a small group of market participants, in particular, global financial institutions, giving rise to potential contagion risks and domino effects. More broadly, the central banker said that financial stability cannot be subordinated to the efficiency of central counterparties. While recognizing that it would be desirable for derivative users if the central counterparties became interconnected because the users would not need to join a number of different central counterparties in order to settle contracts with counterparties that use other central counterparties, the board member warned against the contagion dangers that interconnected central counterparties would represent. All of this serves to illustrate why regulators must continue to keep a close watch on the future development of the derivatives markets. In
he noted, EMIR offers a good starting point for regulators to ensure that the
changes now under way help achieve greater stability in the financial system.
Finally, the central banker said that appropriate recovery and resolution regimes need to be available for central counterparties in case of emergencies. The envisaged loss allocation rules are one core element in designing these regimes.