Members of the Futures Industry Association (FIA) and ISDA welcome HM Treasury’s (HMT) proposals for an expanded resolution regime for UK central counterparties (CCPs), which, due to the UK’s active participation and contributions, are mostly in line with international guidelines and are closely aligned with the EU’s CCP recovery and resolution framework.
Resilient and robust clearing is extremely important to the associations’ membership. ISDA and FIA have been significantly involved in the discussion on CCP recovery and resolution, including developing tools like variation margin gains haircutting (VMGH) and partial tear-up (PTU).
The associations are broadly in agreement with the proposed framework, but have the following key comments and recommendations:
Due to the global nature of UK CCPs, the associations recommend including language in the UK’s final framework to ensure the resolution authority will have due regard to financial stability implications for third countries when resolving a failed CCP.
The current proposal would disproportionately allocate losses to clearing members despite the inclusion of a no-creditor-worse-off (NCWO) framework.
The associations recommend the inclusion of compensation for clearing participants (clearing members and their clients) for all losses in recovery and resolution.
The power to suspend early termination rights needs to be more clearly defined to ensure it does not impact legal netting.
The associations question the appropriateness of the CCP in resolution determining a ‘commercially reasonable tear up price’, especially in light of the fact that PTU is not considered a tool for loss allocation.
The associations welcome that the NCWO safeguard includes fewer indirect costs that are difficult to value (for instance, like re-hedging costs under stressed market conditions or costs for margin at a new CCP), but would appreciate more details to fully assess the proposal.
The associations welcome the introduction of a second tranche of CCP skin in the game, yet they propose that the second tranche should be, at a minimum, the size of the first tranche given that UK CCPs are globally systemically important.
The associations strongly recommend not using cash calls to cover non-default losses (NDL), as these risks are solely managed by the CCP. CCP equity should be right-sized to deal with potential NDLs.
The associations do not agree that loss allocation tools, such as cash calls or VMGH, should be used for recapitalizing a failed CCP. This is particularly the case when such tools may be used without passing the ownership of the CCP to the clearing participants that provided the new capital.
The associations welcome the fact that initial margin is excluded from the write-down tool. This, however, means that the only significant resource that can be written down will be the default fund. Not only is it inappropriate to use this to cover NDL, but it also places the majority of loss absorption on clearing members.
While the associations recognize certain advantages of the power to delay enforcement of a clearing member’s obligation, they strongly recommend HMT implements this power in an equitable manner and carefully analyses the interplay with the NCWO safeguard.