The Commodity Futures Trading Commission's market risk advisory committee discussed several issues related to clearinghouse default management at a meeting on June 27.
Although the advisory committee has no authority to draft rules or set policies, its members provide the CFTC with industry perspectives on market risk issues. The meeting highlighted several concerns that market participants want global regulators to consider as they develop new standards for clearinghouse resiliency, recovery and resolution.
The meeting also highlighted the relationship that the CFTC is building with the Federal Deposit Insurance Corporation, the U.S. government agency that oversees the resolution of troubled banks. Under the Dodd-Frank Act, the FDIC now has responsibility for clearinghouse resolution as well. Staff from both agencies gave presentations on the policies they have developed for dealing with the possible failure of a clearinghouse and/or its major members.
Representatives from CME Group, Intercontinental Exchange and LCH.Clearnet Group spoke at length about their efforts to improve their coordination in default management, a key issue for clearing members that belong to multiple clearinghouses. For example, they are conducting joint default management drills and standardizing their auction processes, and working to rotate traders seconded by clearing firms so that one firm does not have to provide traders for multiple clearinghouses.
A major concern raised by representatives of clearinghouses and asset managers at the meeting related to the issue of "porting," the ability to transfer customer positions and collateral out of a failed clearing firm to another clearing firm. The participants warned that this will be more difficult going forward, given the decline in the number of clearing firms as well as the impact of new capital requirements on the cost of accepting new clients.
One critical point of disagreement was on the issue of whether variation margin posted by customers should be included in the resources available to absorb losses from the default of a clearing firm. BlackRock argued that variation margin should not be used except as a last resort and under extremely stringent conditions, and said it would prefer an increase in other loss-absorbing resources even if that pushed up the overall cost of clearing. CME argued that the use of variation margin should not be ruled out in case of an emergency, but emphasized that the chance of this actually happening is extremely low, given the amount of the other loss-absorbing resources at clearinghouses as well as the amount of capital that large banks are now required to hold.
A key issue in a default scenario will be the balance between recovery and resolution. CME warned that regulators should not preempt a clearinghouse's efforts to recover from a default by pushing too early for resolution, and urged regulators to allow clearinghouses to use discretion in how they manage a default. BlackRock countered that regulators should be ready to move quickly into resolution if a clearinghouse's default waterfall has been depleted. BlackRock also called for more transparency into margin methodologies, stress testing and other aspects of clearinghouse default management so that asset managers can conduct more thorough due diligence on their risk exposures.
