Wednesday, November 26, 2014

ESMA Chair Calls for Resolution Authority for Derivatives Central Counterparties

Crafting an appropriate recovery and resolution framework for derivatives central counterparties is now the main challenge facing the European Union, said Steven Maijoor, Chair of the European Securities and Markets Authority (ESMA). In remarks at the CFA Institute in Brussels, he warned that the systemic impact of a failure of a large central counterparty would equal, or even exceed, the systemic impact of the failure of a large international bank. While the failure of a central counterparty is a very low probability, he conceded, it cannot be fully excluded and it would have quite severe consequences for the market. EMIR provides many benefits for the market in terms of risk management and netting, he noted, but it will also increase risk concentration within central counterparties.

Proposals for a resolution regime for central counterparties are currently being prepared at the global and E.U. level. Several key questions remain to be solved in this perspective, he observed, notably clarifying when recovery and resolution should be triggered, the tools that may be used in each situation and the nature of the resolution authority.

He emphasized that it is of utmost importance that E.U. policymakers speed up the process of having a recovery and resolution framework in place as soon as possible. With the move towards central clearing of derivatives, central counterparties are becoming more and more systemically relevant. Not having the recovery and resolution framework in place now is, he analogized,`` like letting ships leave for their maiden trips without any lifeboats on board.’’

More specifically, derivatives central counterparties tend to increase margin

requirements and haircuts during times of stress which, in turn, could lead to asset price declines and further margin calls, thus fueling negative feedback loops. This issue is explicitly recognized in EMIR and should be taken into account by central counterparties when calculating margin requirements and haircuts on collateral. That said, the practical implementation of this requirement now needs to be monitored.