New EU rules for safer CCPs

New EU rules for safer CCPs

The European Commission has published a proposed Regulation on the Recovery and Resolution of CCPs.

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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:

  • Develop detailed recovery plans, specifying a range of recovery actions and linking these to event triggers. The recovery actions should include raising additional capital resources, cash calls, imposing haircuts on variation margins, book re-matching and voluntary auctions of defaulters’ positions to remaining members.
  • Respond to any demands by their supervisor to enhance the credibility of their recovery plan. This may require amendments to the plan itself, or more fundamental up-front changes to organisational and legal structures, contractual terms, resourcing and capital strength.
  • Provide all required information to their resolution authority to enable that authority to develop a credible and feasible resolution plan.
  • Respond to any demands by their resolution authority to make up-front changes to remove or address impediments to an orderly and effective resolution.

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:

  • Voluntary auctions or forced allocations of the positions of defaulting clearing members to the remaining members;
  • Imposing haircuts on outgoing variation margin payments; and
  • Making a ‘resolution cash call’, up to an amount equivalent to each members’ contribution to the default fund of the CCP (this would be additional to the default fund itself).

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.

Scope

The proposed Regulation applies to all EU CCPs and to their clearing members.

Proportionality

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.

Recovery plans

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

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.

Resolution powers

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:

  • Removing the voting rights of shareholders (the BRRD and EMIR would be amended to enable this to be done without contravention of Company Law protections), and appointing a special manager to replace the Board of a CCP under resolution.
  • Imposing a temporary moratorium on payments by the CCP.
  • Enforcing any existing and outstanding rights of the CCP, including any contractual obligations by clearing members to meet cash calls, to provide additional resources to the CCP, or to take on positions of defaulting clearing members, whether through an auction or other agreed means in the CCP's operating rules; and any existing and outstanding contractual obligation committing parties other than clearing members to any forms of financial support to the CCP. This would usually precede the use of any of the next four powers.
  • Selling or transferring the ownership, assets, liabilities, rights and obligations of the CCP, in whole or in part. This would not require any consent of the shareholders of the CCP or of any third party other than the purchaser.
  • Establishing a bridge CCP and transferring all (or some) of the CCP’s business to the bridge CCP. In particular, the critical economic functions of a CCP could be transferred initially to a bridge CCP, and then eventually sold to another entity, while the residual parts of that CCP would be wound up in accordance with normal insolvency proceedings.
  • Writing-down the equity, debt and unsecured senior liabilities of the CCP, or converting debt and unsecured senior liabilities into new equity or other capital instruments.
  • Going beyond the ‘default waterfall’ (as specified under EMIR) to allocate losses or positions to clearing members, through voluntary auctions or forced allocations of defaulters’ positions; the partial or full tear-up of contracts (of the clearing member in default, or of the CCP itself); haircuts on outgoing variation margin payments; and ‘resolution cash calls’ on clearing members, up to an amount equivalent to each members’ contribution to the default fund of the CCP or the affected clearing service.

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

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.

Timing

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.

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