The International Swaps and Derivatives Association (ISDA) has issued a position paper setting out a proposed recovery and continuity framework for central counterparty (CCP) clearinghouses.
The position paper, “CCP Default Management, Recovery and Continuity,” outlines a “framework for recovery and sets out tools that can be used to re-establish a matched book following the default of one or more clearing members,” ISDA says in a statement. “The paper does not cover non-default losses and those relating to liquidity shortfalls.”
The recovery measures include a “portfolio auction of the defaulted clearing member’s portfolio, limited cash calls to solvent clearing members, loss-allocation mechanisms in the form of a pro-rata reduction of unpaid obligations of the CCP, and consideration of a partial tear-up of contracts to re-establish a matched book,” ISDA specifies, noting that clearing houses have “become vital to derivatives market infrastructure following the implementation of new regulations that require standardized over-the-counter derivatives to be cleared. As a result of their systemic importance, CCPs are required to develop recovery plans to avert a threat to their viability and ensure they can maintain the continuity of critical services without requiring the intervention of resolution authorities or resorting to public money.”
The ISDA statement also outlines the following three principles:
One, “recovery of a CCP is preferable to its closure. As a result, recovery efforts should continue so long as the CCP’s default management process is effective, even if pre-funded resources have been exhausted. In the event the default management process hasn’t been effective in re-establishing a matched book – signaled by a failed auction – the CCP may have to consider the closure of the clearing service. At this point, it is likely that resolution authorities will be considering whether this should trigger resolution.”
Two, “recovery methods should be clearly defined in clearing service rule books to provide transparency and predictability over the maximum time frame for the default management process before recovery tools are deemed to have failed.”
Three, “clearing services should be segregated and structured to be of limited recourse to the clearing provider to mitigate the potential for contagion across other clearing services of the CCP.”
“Many clearing houses are systemically important and it’s vital they have robust mechanisms in place in order to recover from a threat to their viability,” Scott O’Malia, ISDA CEO, says in the statement. “ISDA and its members believe that the recovery of a clearing service is preferable to its closure, and we think the proposed recovery framework outlined in this paper offers a comprehensive and effective set of detailed measures to ensure a CCP’s ongoing viability”
The paper is available on the ISDA website at http://www2.isda.org/functional-areas/risk-management/.
Need a Reprint?
Leave a Reply