The European Commission has published a proposed Regulation (PDF 896KB) on the Recovery and Resolution of CCPs. This follows a consultation exercise back in 2012. The proposed Regulation will be submitted to the European Parliament and the Council of the EU for their approval and adoption.
The underlying rationale for this legislation is that all EU CCPs are regarded as being of systemic importance, so it may be necessary to use resolution tools to (i) preserve the continuity of critical functions provided by a failed or failing CCP; and (ii) impose any losses and costs of recapitalisation on the owners, creditors and counterparties of the failing CCP, rather than on taxpayers.
The structure and provisions of the Regulation are broadly similar to the Bank Recovery and Resolution Directive (BRRD), while reflecting some CCP specific issues and the guidance on the resilience and recovery of CCPs issued jointly by the Committee on Payments and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO), and by the Financial Stability Board (FSB).
Implications for CCPs and clearing members
For CCPs, the main implications (as with banks and investment firms covered by the BRRD) relate to the requirements on them to:
For clearing members, the proposed Regulation supplements the European Markets and Infrastructure Regulation (EMIR) – which establishes minimum capital requirements and the ‘default waterfall’ for CCPs - by setting out the powers of a CCP resolution authority to allocate the losses or positions of a CCP in resolution to its clearing members, including by:
In addition, shareholders of the CCP could have the value of their shareholdings written off in a resolution, while bond holders and senior unsecured creditors could be subject to either the writing-down of the value of their claims or the conversion of these claims into new equity of the CCP.
The proposed Regulation applies to all EU CCPs and to their clearing members.
Although the Regulation applies to all CCPs there is scope for some proportionality through the development of recovery and resolution plans that are specific to each CCP.
Resolution authority and college
A resolution authority has to be appointed for each CCP, and to be granted the resolution powers outlined below. The Regulation does not specify who this should be – as with banks, it could be a central bank, a supervisor or a stand-alone authority.
There should also be a resolution college for each EU CCP, to discuss the recovery and resolution plans for the CCP. These colleges will have a very wide membership, which must call into question the operating effectiveness of each college – under the proposed Regulation the membership should include the resolution authority; the supervisors of the CCP; the supervisors and resolution authorities of the CCP’s clearing members; the supervisors of securities depositories linked to the CCP and of trading venues served by the CCP; the relevant central bank(s) depending on the currencies in which the CCP operates; ESMA and EBA (on a non-voting basis, to monitor how well the college is working); and the Ministry of Finance.
Each CCP should develop a recovery plan. This should take account of a range of severe but plausible adverse shocks, include a range of recovery actions, and establish a set of ‘trigger’ events with corresponding presumptive recovery options. The recovery actions should include plans to raise new equity, sell non-core business lines, cash calls from clearing members, book re-matching, voluntary auctions of defaulters’ positions to remaining members, and haircuts on variation margins.
The CCP should ensure in advance that these actions would be binding in other countries, where relevant. Recovery options should therefore constitute contractual obligations under the law of the country in which the CCP is established, or enforceable under the law of a third country.
The supervisor of the CCP then undertakes an assessment of the recovery plan, to determine whether it is credible and feasible. Under the proposed Regulation the supervisor would have the power to require a CCP to amend its recovery plan and, if necessary, to require fundamental up-front changes to the organisational and legal structure, contractual terms, and resourcing and capital strength of the CCP.
Resolution plans will be drawn up by the resolution authority, based on information provided by each CCP. The resolution authority will undertake a resolvability assessment; consider how any impediments to an effective and orderly resolution could be removed or addressed; and will have the power to require a CCP to make up-front changes to facilitate its resolvability.
Early intervention powers
Supervisors of CCPs will have early intervention powers, including the power to require a CCP to trigger elements of its recovery plan, and the power to remove all or some of the senior management and Board of a CCP and to replace them with new senior management or Board.
Putting a CCP into resolution
The Regulation sets out three criteria for triggering a resolution – a CCP has failed or is likely to fail; there is no reasonable prospect of a private sector solution (for example through the activation of the CCP’s recovery plan or through the sale of the CCP); and it is in the public interest to put the CCP into resolution (rather than winding down the CCP under normal insolvency proceedings).
The Regulation does not specify who should take the decision to put a CCP into resolution – this could be the supervisor, the resolution authority or a committee. But ESMA would have a binding mediation role.
Once a CCP was put into resolution, the resolution authority would have a wide range of powers. These could be used singly or in combination:
As with the BRRD for banks, the ‘no creditor worse off than under liquidation’ would apply, with implications for undertaking valuations both at the time of resolution and at some point post-resolution.
The resolution authority may also need to arrange access to central bank liquidity, subject to the agreement of the relevant central bank(s).
Government support for a failing or failed CCP is allowed for under the proposed Regulation, but only as last resort that would also need to comply with State Aid rules. Unlike the BRRD, there is no mention of a minimum amount of prior writing-down of liabilities before government support could be considered, nor any mention of the establishment or use of a resolution fund.
If government support was provided, the Regulation states that the costs should be recovered in the medium term from the value of the rescued CCP or from the rest of the financial system.
Related amendments to BRRD and EMIR
Proposed amendments to the BRRD would carve CCPs with banking licences out of scope of the BRRD, bringing them exclusively under the arrangements and requirements of the CCP Regulation.
EMIR would be amended to allow for the possibility for a clearing obligation to be temporarily suspended under the resolution of a CCP, where this is necessary to preserve financial stability and market confidence.
The intention is that the proposed Regulation should take effect once the Commission proposal amending the BRRD (BRRD2 – as proposed on 23 November) takes effect.