Benoît Coeuré: Risks in Central counterparties (CCPs)
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the policy panel during the conference "Mapping and Monitoring the Financial System:
Liquidity, Funding, and Plumbing", organised by the Office of Financial Research and
Financial Stability Oversight Council, Washington DC, 23 January 2014.
* * *
I would like to thank Andreas Schönenberger for his contribution. I remain solely responsible for the opinions contained
herein.
Accompanying slides can be found on the European Central Banks' website:
http://www.ecb.europa.eu/press/key/date/2014/html/sp140123_1.en.pdf.
Ladies and Gentlemen,
I am delighted to participate in this policy panel today on a topic of high importance to the
ECB from the perspective of monetary policy implementation, financial stability, and banking
supervision.
Central counterparties (CCPs) play a key role in the financial markets by managing and
structuring a complex web of counterparty risk. As such, risks in CCPs are of interest to
CCPs themselves, their clearing members and the regulators who supervise them.
What I would like to do in my brief introductory remarks is therefore not only to focus on the
risks in CCPs, but also and importantly on the risk of CCPs.
The growing importance of CCPs certainly brings a number of important benefits that
alternative bilateral arrangements could not do to the same extent. However, the rise of
central clearing may also be accompanied by some unintended side effects that need to be
addressed.
The growing importance of central clearing
First, however, let me illustrate the growing importance of central clearing on the basis of
some figures [Slide 2]. The figures show the importance of CCPs already today for interest
rate and credit derivatives in Europe. There are also CCPs for cash products and the role
these CCPs would play for collateral pools of triparty repos is of increasing importance.
With the forthcoming implementation of the central clearing requirement for standardised
OTC derivatives contracts, the volume of transactions cleared by a CCP will rise significantly
also in that market segment over the coming years [Slide 3]. A recent quantitative impact
study run by the Working Group on Margining Requirements of the Basel Committee on
Banking Supervision (BCBS) and the International Organization of Securities Commissions
(IOSCO) estimated that the global volume of centrally cleared OTC derivatives could rise
from a notional value of USD 142.7 trillion, or around 28% of OTC derivatives traded, to
USD 268 trillion after migration to the clearing requirement, or 53% of OTC derivatives
traded. All these figures quite forcefully demonstrate the increasing systemic importance of
CCPs.
Now, why is there such a push for central clearing and what does that mean from a systemic
risk perspective?
Central clearing: benefits and side effects
I see four main benefits that explain the market-driven and regulatory push for central
clearing [Slide 4].
First, CPPs overcome information asymmetries that typically exist in marketplaces, especially
markets with a big number of heterogeneous players. CCPs allow participants to trade with
one a single counterparty (the CCP), which greatly facilitates the due diligence efforts and
risk management burden that counterparties normally face.
Second, CCPs offer state-of-the-art margining and risk management methods that do not
exist to the same extent in the bilateral world, which either relies on standardised margining
methods that are not very risk-sensitive or on bank-internal margining models that may not
necessarily meet the same high standards that CCPs are required to meet.
Third, by introducing default and clearing funds, CCPs are able to mutualise losses in a
transparent and predictable way, which makes it easier for financial markets to handle huge
losses and liquidity shortfalls that may occur in catastrophic events. By carefully designing
their risk management framework, CCPs can help to ensure that losses fall predictably on
those who are better able to cope with them. More generally, central clearing introduces ex
ante transparency and therefore certainty, provided that the rules are clear and well
understood by market participants.
Finally, and most importantly, central clearing allows for the multilateral netting of exposures
so that a given level of risk protection can be achieved with a smaller amount of collateral, or
vice versa, a given amount of collateral can achieve a higher level of risk protection.
Notwithstanding the numerous benefits of central clearing, the rise of central clearing may be
associated with a number of side effects [Slide 5].
First, risk concentration within CCPs will grow, both nationally and internationally. CCPs are
increasingly turning into institutions of unprecedented systemic importance. Their failure
could lead to very serious systemic disruptions, which is why not only sound risk
management, but also an effective recovery and resolution regime for CCPs is key.
Second, a growing number of banks will participate in key CCPs across the globe. It is
essential that the financial institutions that participate in and rely on CCPs are able to
conduct effective due diligence to understand the risks they face as members and take
appropriate steps to mitigate those risks.
Third, owing to mutualisation, losses and liquidity shortfalls in the event of a member default
may spread to other participants. Crisis propagation may be further driven by
interdependencies of changing complexity. These can exist between CCPs and other
financial institutions, for example, through interoperability arrangements. Note that the same
large financial institutions, being clearing members of many CCPs, increase
interdependencies even in the absence of interoperability.
Finally, existing differences in regulation may lead to regulatory arbitrage and potentially to a
race to the bottom. Moreover, the use of a centralised infrastructure depends, in some
instances, on exemptions from registration or the application of equivalence or substituted
compliance with foreign infrastructures. Where foreign CCPs cannot be used, compliance
with mandatory clearing under domestic laws may inhibit cross-border transactions.
New risks related to central clearing
The globalisation process has triggered a trend towards global clearing that in itself may lead
to further unintended consequences and may create new risks [Slide 6]. The trend towards
increasingly large global CCPs is similar in nature to that of horizontal integration which the
Committee on Payment and Settlement Systems (CPSS) looked at in greater detail in a
report of 20101, concluding that larger global CCPs may have certain advantages, but may
also lead to systemic risks, reduced benefits of central clearing, and regulatory frictions.
Moreover, it appears that for many banks, indirect access is their preferred way to get access
to clearing services so as to comply with the clearing obligation. Client clearing seems thus
to be dominated by a few large global intermediaries. A factor contributing to this
concentration may be higher compliance burdens, where only the very largest of firms are
capable of taking on cross-border activity. This concentration creates a higher degree of
dependency on this small group of firms.
There are also concerns about client access to this limited number of firms offering client
clearing services. For example, there is some evidence of clearing firms "cherry picking"
clients, while other end-users are commercially unattractive customers and hence unable to
access centrally cleared markets.
These are all developments that I believe the international regulatory community may wish to
carefully monitor and act on as and when needed.
The consequences of regulatory reforms
There are a number of (sometimes unintended) consequences of regulatory reforms that
CCPs, regulators, and clearing banks need to respond to [Slide 7].
First, perhaps most obviously, the growing reliance and importance of CCPs calls for higher
risk management standards, which has led to the revision of the CPSS-IOSCO Principles for
financial market infrastructures, specifying a number of new and/or more demanding
requirements for CCPs2.
Second, it is essential that the financial institutions that participate in and rely on CCPs are
able to conduct effective due diligence to understand the risks they face as members and
take appropriate steps to mitigate those risks. It is very welcome therefore that the Payments
Risk Committee issued last year their "Recommendations for Supporting Clearing Member
Due Diligence of Central Counterparties"3, which complement CPSS-IOSCO new quantitative
disclosure requirements. It is also important that banks are subject to strict capital and
liquidity requirements on their exposures to CCPs, while at the same time preserving the
incentives for central clearing.
Third, given the dramatic consequences that a CCP default would have for financial stability,
it is vital that there are robust recovery and resolution regimes for CCPs. The CPSS-IOSCO
and Financial Stability Board (FSB) have made good progress to that end.
Fourth, it is important to react swiftly to any structural developments that may cause systemic
disruption. The FSB and the standard-setting bodies, in particular the CPSS, continuously
monitor any such developments to that end.
Finally, I would not exclude that there could be a need for further adaptations and guidance
on some selected regulatory requirements for CCPs if needed to ensure cross-border
consistency in regulation. In addition to the recognition processes by individual jurisdictions,
the ongoing monitoring by the CPSS-IOSCO of the implementation of the Principles for
financial market infrastructures provides an opportunity to identify possible inconsistencies at
a global level4.
Conclusion
Let me conclude [Slide 8].
The trend towards more central clearing is welcome and needed as it helps to manage risks
better than bilateral clearing could. However, the greater use of CCPs concentrates and
redistributes risks and may even create new risks.
Much progress has been achieved by CCPs, banks and authorities to ensure high risk
management standards of CCPs and enable clearing members to conduct due diligence. It
strikes me however that further efforts are needed to be able to cope with CCP default, to
address risks associated with changes in market structures, and to remove cross-border
differences in regulation where needed.
I thank you for your attention.