Memo #
31516

Financial Stability Board Discussion Paper on CCP Resolution - Member Call on 17 December at 2pm GMT/9am ET
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[31516]

December 10, 2018 TO: Derivatives Markets Advisory Committee
ICI Global Regulated Funds Committee
ICI Global Trading & Markets Committee RE: Financial Stability Board Discussion Paper on CCP Resolution - Member Call on 17 December at 2pm GMT/9am ET

 

On 15 November 2018, the Financial Stability Board (FSB) published a discussion paper (DP)[1] on financial resources to support central counterparty (CCP) resolution and the treatment of CCP equity in resolution. The FSB is inviting comments on the DP by 1 February 2019 (a full list of questions is in the annex). ICI Global intends to submit a comment letter and will hold a member call to discuss the DP on Monday 17 December at 2pm GMT/9am ET. Dial in details for the call are below:

UK: 0330 336 0036
United States +1 415 363 0833
Participant PIN: 468761

Please let Lesley Dunn know if you can join the call (Lesley.Dunn@iciglobal.org or +44 207 961 0830).

Background

The DP is part of the FSB’s ongoing work on financial resources to assist authorities in their resolution planning for CCPs. It builds on earlier work undertaken by CPMI-IOSCO to develop principles for financial market infrastructures (“PFMI”)[2] and FSB guidance on CCP resolution and recovery (“FSB Guidance”).[3] The FSB has previously stated that, based on further analysis and experience gained in resolution planning, it will determine the need for any additional guidance.[4] Responses to the DP will help inform the development of this further guidance by 2020. The annex to this memorandum lists the questions the FSB asks in the DP.

The DP is split into two sections. The first section sets out a proposed five-step process for the assessment of the adequacy of financial resources to support resolution. The second section considers the treatment of CCP equity in resolution. The FSB is inviting comments on the DP, including the 17 questions it has set out in the DP under the various section and sub-section headings below.

Assessing the adequacy of financial resources to support resolution

The existence of a stable and robust central clearing system depends, in part, on the existence of adequate financial resources to support CCPs. The PFMI establishes standards for various aspects of the financial resources maintained by CCPs, including: (i) the availability of CCP equity to absorb losses; and (ii) loss allocation arrangements. Furthermore, the PFMI and other FSB guidance recommend that supervisors of systemically important CCPs that are systemically important develop resolution strategies for these CCPs.

A critical component of resolution planning is understanding what resources would be available to resolve a CCP, and the DP proposes the following five-step process for supervisors to assess the adequacy of a CCP’s financial resources:

  1. The identification and analysis of hypothetical default and non-default loss scenarios that may lead to resolution;
  2. Qualitative and quantitative assessment of existing resources and tools available in light of the loss scenarios in step 1 when applied in resolution;
  3. Analysis of potential resolution costs;
  4. Comparison of existing tools and resources to full resolution costs and identification of any gaps; and
  5. Consideration of the availability, costs and benefits of different means of addressing any gaps identified in 4.

Each of these steps is described in more detail below. The DP also proposes various factors and circumstances that should be taken into account when assessing the adequacy of a CCP’s financial resources, including the profile of CCP participants, the type and services provided by the CCP, and any interoperability arrangements. These factors also could influence the design of the CPP’s resolution strategy and resolution plan.

1. Identifying hypothetical default and non-default loss resolution scenarios (Q4)

The FSB identifies the following non-exhaustive list of hypothetical default loss scenarios that it believes may cause a CCP’s loss allocation arrangements to fail:

  • The CCP has not established resources and tools called for by existing CPMI-IOSCO standards;
  • The CCP’s loss allocation arrangements set out in the recovery plan do not operate as intended, so that the resources are not in fact available or the tools are not able to be used at the time of recovery;
  • Multiple clearing members do not meet their obligations under the CCP’s recovery actions; and
  • The CCP’s recovery plan is consistent with the PFMI but the relevant authorities determine that resolution should be initiated before some of the arrangements or tools under the CCP’s recovery plan are applied, because their application could threaten financial stability and/or the continuity of critical functions in the prevailing market conditions.

The FSB also identifies examples of different types of risk that it believes may cause a CCP to suffer loss (but not lead to default), including investment, operational and legal risks and the failure or non-performance of a third party such as a custody bank, settlement platform, payment bank, concentration bank or other service provider. The FSB lists the following four non-exhaustive scenarios where it believes CCP’s recovery plan may not be sufficient to cover fully potential non-default losses and resolution may be called for:

  • The CCP does not meet existing CPMI-IOSCO standards, or does not have sufficient financial resources to cover non-default losses;
  • The CCP’s loss allocation arrangements, where they exist, address (specific) nondefault losses in a comprehensive manner but do not operate as intended, so that the resources are unavailable or cannot be replenished or the tools are not able to be used at the time of recovery;
  • The CCP’s clearing members and/or shareholders do not meet their obligations or do not support the CCP’s recovery actions;
  • The CCP’s recovery or wind-down arrangements are consistent with the PFMI but the relevant authorities determine that resolution should be initiated before some of the arrangements or plans are applied, because their application could threaten financial stability and/or the continuity of critical functions in the prevailing market conditions. 

2. Evaluating existing tools and resources for resolution

The FSB proposes that relevant supervisors undertake a qualitative and quantitative evaluation of a CPP’s existing recovery and resolution tools and resources, against resolution strategies, including in respect of the areas below.

Default loss scenarios

Non-default loss scenarios

Cash calls

Availability and effectiveness of insurance coverage and other third-party resources in resolution

Variation margin gains haircutting

Allocation of losses to participants

Full tear up, partial tear up or other position allocation/matched book tools

Allocation of losses to creditors in resolution

CCP equity

Replenishment of minimum resources

 

Statutory powers of the Resolution Authority

 

3. Analysing full resolution costs

The FSB proposes that relevant supervisors should assess the different types of cost that could arise from the resolution of a CCP in the various default and non-default scenarios identified in step 1. The FSB proposes that this assessment includes: (i) the amount of losses of the CCP and the costs of replenishing its financial resources; and (ii) operational costs that may be incurred by the resolution authority, including its own additional costs (e.g. legal and accounting fees) and costs of maintaining the continuity of critical functions of a CCP. The FSB indicates that the analysis of full resolution costs should consider, among other things, who incurs costs and whether these costs may be ultimately recoverable.

4. Comparing existing tools and resources to resolution costs and identification of any gaps

To identify shortfalls and gaps between existing tools and resources (Step 2) and resolution costs (Step 3), the FSB proposes that relevant supervisors undertake a gap analysis between the two.

5. Considering the availability, costs and benefits of potential means of addressing gaps

To the extent that the Step 4 gap analysis identifies any gaps between existing tools and resources and resolution costs, the FSB proposes that relevant supervisors consider, as part of resolution planning, options to address the identified gaps, the tools and resources needed to implement each option, and the costs and benefits of each option.

Treatment of CCP equity in resolution

Building on the FSB’s prior work to establish general[5] and sector specific[6] guidance on the key attributes of effective resolution regimes, the DP identifies four areas that it believes relevant supervisors should consider to ensure they have a clear understanding of the treatment of equity under existing recovery arrangements, distinguishing between default and non-default loss scenarios: (1) possible mechanisms for adjusting the treatment of CCP equity in resolution; (2) the point in time or in the waterfall for imposing losses on equity; (3) potential challenges and constraints to CCP equity bearing losses in resolution; and (4) policy considerations for the treatment of equity in resolution. We describe each of these areas below.

1. Possible mechanisms for adjusting the treatment of CCP equity in resolution

The FSB identifies the following mechanisms that a resolution authority may use to adjust the exposure of CCP equity to loss in resolution:

  • Exposure of some or all of the equity of the CCP via modification of the contractual loss allocation arrangements;
  • Full or partial write down of equity and cancellation of existing shares;
  • Transferring critical CCP operations (assets and certain liabilities) to a bridge entity and placing the remnant CCP into liquidation/receivership;
  • Dilution of existing shares as a result of raising new capital through conversion, issuance or transfer of new shares.

2. The point in time or in the waterfall for imposing losses on equity

The FSB sets out the following points in time when CCP equity may be exposed to loss:

  • Entry into resolution;
  • A point following entry into resolution that is determined ad hoc and on a case by case basis at the discretion of the resolution authority;
  • One or more specific, fixed point(s) in the loss allocation waterfall (including in parallel to the use of other resources in the waterfall).

3. Potential challenges and constraints to CCP equity bearing loss in resolution

The FSB identifies the following challenges and constraints that could prevent losses being imposed upon CCP equity in resolution:

  • No creditor worse off than in liquidation (NCWOL) claims by shareholders;
  • Lack of powers to impose losses on equity in resolution.

The FSB is inviting comments on the challenges and constraints it has identified, including whether there are others and how those might be addressed (Q13). Furthermore, whether authorities can reconcile the expectations that equity bears loss with the NCWOL safeguard.

Policy considerations for the treatment of equity in resolution

The FSB sets out the following policy considerations which may guide resolution authorities in determining whether any adjustments to the treatment of equity in loss resolution scenarios would be appropriate:

  • Impact on CCP management incentives to purse sound risk management;
  • Impact on clearing member incentives to support recovery and avoid resolution;
  • Impact on clients;
  • Impact on continuity of critical clearing services following resolution; and
  • Impact on different business models and legal structures of CCPs.

The FSB is inviting comments on the whether the policy considerations it has identified are appropriate and comprehensive and whether there are additional ones to include.

 

Giles Swan
Director of Global Funds Policy, ICI Global

George M. Gilbert
Assistant General Counsel

 

Attachment

endnotes

[1]Financial resources to support CCP resolution and the treatment of CCP equity in resolution, Discussion paper for public consultation, Financial Stability Board, 15 November 2018, available at http://www.fsb.org/wp-content/uploads/P151118-2.pdf

[2] Principles for financial market infrastructures, CPMI-IOSCO, April 2012, available at https://www.bis.org/cpmi/publ/d101a.pdf

[3] Guidance on Central Counterparty Resolution and Resolution Planning, Financial Stability Board, 5 July 2017, available at http://www.fsb.org/wp-content/uploads/P050717-1.pdf

[4]  FSB Guidance at 1.

[5] Key Attributes of Effective Resolution Regimes for Financial Institutions (“Key Attributes”), Financial Stability Board, 15 October 2014, available from http://www.fsb.org/wp-content/uploads/r_141015.pdf

[6] Appendix II, Annex 1 Resolution of Financial Market Infrastructures (FMIs) and FMI participants, Key Attributes