On 28 November 2016 the European Commission (the Commission) issued a proposal (the Proposal) for a Regulation on a framework for the recovery and resolution of central counterparties (CCPs).
According to the Commission’s factsheet issued at the same time as the Proposal, CCPs increase stability in financial markets and are critical in helping reduce risks in the wider economy. The recovery and resolution framework put forward in the Proposal will reduce the risk of a CCP failing, ensure the continuation of a failing CCP’s critical functions and provide national resolution authorities with tools for the resolution of a failing CCP. This will help maintain financial stability, reduce the risk of contagion to other parts of the financial markets and prevent the cost of any resolution being borne by taxpayers.
CCPs interpose themselves between counterparties to contracts traded on various financial markets, acting as buyer to every seller and as seller to every buyer. In the EU there are currently 17 CCPs that clear a significant proportion of the EUR 500 trillion of derivatives outstanding. This figure will increase following implementation of the requirement to clear standardised OTC derivatives through CCPs. An uncontrolled CCP failure, therefore, is likely to have catastrophic consequences for the financial markets, with the level of inter-connectedness between CCPs and other FMIs creating a high risk of contagion. Because of this central role and the potential wide-spread consequences of a CCP failure, the Commission considers that CCPs are systemically important. EMIR does not contain a framework for the resolution or recovery of a failing CCP, the Bank Recovery and Resolution Directive (BRRD) does not extend to CCPs and the Commission does not believe that normal insolvency regimes (which often provide for the insolvent entity to cease trading and which could disrupt the provision of critical services by the CCP). It was felt therefore that a specific framework for the recovery and resolution of CCPs was required.
The Proposal builds on the principles found in the BRRD and those familiar with the BRRD will recognise may of the concepts contained in the Proposal. Note, however, that unlike the BRRD this will be a Regulation with direct effect in Member States. The key elements of the Proposal are as follows:
- Each Member State must nominate one or more bodies to be the national resolution authorities for CCPs (NRAs). The NRAs are then required to set up resolution colleges which largely mirror the composition of colleges in EMIR. The resolution college will include the relevant central banks and ESMA. Generally, consideration of a CCP’s recovery and resolution plans will be done jointly by the NRA and the resolution college for that CCP;
- CCPs will have to prepare and submit recovery plans to the NRAs on an annual basis. Some jurisdictions, including the UK, already require recovery plans from CCPs, but the Regulation will place that requirement onto a more formal and harmonised basis. The recovery plan will set out the arrangements the CCP has put in place to allow it to take steps to restore its long-term viability and ensure the provision of critical services. Plans should include arrangements agreed between the CCP and its clearing members, to ensure such arrangements are effective regardless of the jurisdiction in which the clearing member is located. Recovery plans should be prepared on the basis that no public financial support will be required to implement the plan;
- NRAs, with the assistance and co-operation of the CCP, will prepare resolution plans. The resolution plan will set out how the CCP would be restructured and its critical functions kept alive in the event of the a failure. If the NRA identifies an impediment to resolvability during the course of preparing the plan, the NRA will have the power to require the CCP to take appropriate measures to address the issue, including changes to its operational or legal structure or to its pre-funded loss-absorbing resources. The plan must ensure that the resolution will protect financial stability and be carried out without involving costs to taxpayers;
- Supervisory authorities will have the power to intervene at an early stage when a CCP’s viability is at risk but before the CCP reaches the point of failure or where the CCP’s actions may be detrimental to the overall financial stability. This could include requiring the CCP to put into action part of its recovery plan;
- NRAs will have a wide range of resolution tools to deal with a CCP which is failing or is likely to fail, when no private sector alternative can avert failure and when failure would jeopardise the public interest and financial stability. The main resolution tools are as follows:
- The sale of business tool;
- The bridge CCP tool where the essential functions of the CCP would be put into a bridge CCP with a view to a private sale at a later date;
- The position allocation tool which aims at re-matching the book of the CCP through partial or full termination of contracts;
- The loss allocation tools which aim to cover the losses of the CCP and restore its ability to meet its payment obligations through haircutting of variation margin and cash calls enacted through the NRA;
- The write-down and conversion of capital and debt instruments or other unsecured liabilities tool.
- As a last resort, the NRAs can also use:
- The public equity support tool; and
- The temporary public ownership tool.
As with the BRRD, there are certain safeguards which the NRAs have to comply with when using any of the resolution tools (including the “no creditor worse off” principle which provides that no creditor should be worse off through the resolution action than he would have been had the CCP gone into liquidation).
- Resolution action taken in any Member State will be recognised in all other Member States. The Proposal also provides the NRAs with the power to recognise and enforce third country resolution actions provided such actions would not adversely affect financial stability in that Member State. In addition, to safeguard the general enforceability of resolution action taken in a Member State, CCPs will be required to ensure the relevant measures set out in the recovery plans are binding in all relevant jurisdictions (e.g. by including the measures as part of the contractual agreement between the CCP and clearing member). NRAs can require contracts, including operating rules, be amended to facilitate effective resolution of the CPP in all relevant jurisdictions.
The Commission intends for the Regulation to take effect once the Commission’s proposal amending the BRRD (to incorporate provisions on loss absorbing capacity and recapitalisation capacity of credit institutions and investment firms) takes effect. The proposed Regulation will now be submitted to the European Parliament and the Council of the EU for their approval and adoption