EUROPEAN COMMISSION Brussels, 28.11.2016 SWD(2016) 368 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT

Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on a framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No 648/2012, and (EU) 2015/2365

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TABLE OF CONTENTS 1Introduction 1.1.Recovery and resolution of financial institutions 2Procedural issues and consultation of interested parties 2.1Procedural issues 2.2External expertise and consultation of interested parties 2.2.1Stakeholder consultation 2.2.2External expertise 3Policy context, problem definition and subsidiarity 3.1Background and context 3.2Overview of legislative framework 3.3Problem definition 4The EU's right to act and justification 5Objectives 6Principal policy options, Comparison and analysis of the impacts 6.1Baseline scenario 6.2Possible options to increase preparedness of supervisors and CCPs for crisis situations 6.3Possible options to improve early intervention arrangements for authorities 6.4Possible options to ensure resolution of CCPs in a timely and robust manner (scope of tools and trigger for using them)

6.5Possible options to carry out resolution (first set of concrete resolution tools) 6.6Possible loss and position allocation tools (second set of concrete tools in addition to section 6.5) for resolving a CCP 7Overall impacts of the package 7.1Small and medium sized institutions (SMEs) 7.2Administrative costs 7.3EU budget 7.4Fundamental rights 7.5Social impacts 7.6Third country impacts 7.7Environmental impacts 7.8Summary of impact on key stakeholder groups of preferred options 8.Monitoring and Evaluation Annex I – Glossary Annex II – Role and function of Central Counterparties Annex III – International work on CCPs (and other financial market infrastructures) (CPSS/CPMI-IOSCO and FSB) Annex IV – Relevant US regime regarding crisis management of nonbank financial institutions Annex V – The benefits and consequences of CCP clearing Annex VI – Data on European CCPs and recent trends in the increase in OTC clearing Annex VII – Competition and CCP interoperability Annex VIII – How a CCP could fail

Annex IX – CCP financial resources “waterfall” and incentives Annex X – Failures and near-failures of CCPs Annex XI – Numerical examples of loss-allocation tools and stakeholder positions Annex XII – Other options not considered in this impact assessment 1Introduction This impact assessment considers the costs and benefits of an EU-wide recovery and resolution regime for central counterparties (CCPs). A clearing house, acting as a CCP, intervenes between counterparties to financial transactions (through novation ) to assume and carry out their rights and obligations, acting as the buyer to every seller and the seller to every buyer for a specified set of contracts. They clear financial transactions of various types (such as in equities, derivatives and repos) for their clearing members (typically large banks) and the clients of their clearing members (e.g. pension funds and asset managers). This concentration of positions allows them to be netted down to considerably reduce total exposures of the CCP, as well as of its members and clients . CCPs contribute to market stability by imposing credit and other risk management requirements on their members and clients and by mitigating most of the risks inherent in post-trading activities. In exchange for taking on and netting their positions, the CCP collects collateral (‘margin’) from clearing members to cover its liabilities in case any participant defaults on its obligations vis-à-vis the CCP. By doing so, they manage the risks inherent in financial markets (e.g. counterparty risk, liquidity risk and market risk), and therefore improve the overall stability and resilience of financial markets. In the process, they become critical nodes in the financial system, linking multiple financial actors and concentrating significant amounts of their exposure to diverse risks. Effective risk management of the CCP and robust supervisory oversight is therefore key to ensure that such exposures are adequately covered. The scale and importance of CCPs in Europe and beyond is set to increase via the implementation of another G20 commitment, namely the obligation to clear standardised derivatives transacted over-the-counter (OTC) through central counterparties. This obligation is implemented in the EU by the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR). That Regulation also sets out comprehensive prudential requirements for CCPs, as well as requirements regarding the operations and oversight of CCPs. 1.1Recovery and resolution of financial institutions Financial markets are pivotal for the functioning of modern economies. The more integrated they are, the more efficient the allocation of economic resources and long run economic performance will be. However, at the same time, to improve the functioning of the Single Market in financial services, it is important to have procedures in place to ensure that if an important financial institution that is active in this market faces financial distress or is at the point of failure, such an event does not de-stabilise the entire financial market and damage growth across the wider economy. Any failing institution should in principle be liquidated under normal insolvency proceedings. Where such an approach might jeopardise financial stability, interrupt the provision of critical functions to the economy, or affect other market participants disproportionately, and there is a public interest in doing so, resolution tools should be applied by public authorities to ensure the institution can fail in an orderly manner. Such action would avoid the need for the State to bail out the institution concerned with taxpayer money, to stem the threat of financial instability. In this context, CCPs may enter into severe financial distress, exceeding its EMIR resources, due to (i) "member default", when a clearing member(s) is unable to pay its obligations as they fall due or (ii) "other (non-default) causes", in relation to, for instance, operational, business, or legal reasons (such as cyber-attacks, fraud or investment losses). Recovery actions would be undertaken by the CCP with the aim of addressing the cause of the financial distress and restoring its long-term viability. If these actions are insufficient, authorities could place the CCP into resolution with the aim of preserving financial stability and the broader economy, minimising costs of the CCP failure on taxpayers and restoring the viability of critical functions of the CCP. They would do this by allocating losses on private sector participants (e.g. shareholders, clearing members and their clients), to the extent possible and in line with the European Convention of Human Rights, and would wind up the CCP's non-critical functions in an orderly manner. As such, the measures would be designed to preserve the ability of the financial system to fund economic growth and avoid the socio-economic costs of a financial meltdown. Recovery and resolution measures would especially relevant where a financial institution is of such a size, market importance and interconnectedness that its distress or disorderly failure would jeopardise the normal functioning of the financial system, which would in turn adversely impact the real economy, as is the case of CCPs. Due to their different functions and business models, the risks inherent in banks and CCPs vary. Consequently the failure of a CCP may arise, and will resonate, in different ways in comparison to a bank. Based on the responses to the 2012 Commission consultation on a possible recovery and resolution framework for non-banks and on the views of wider commentators, it has been acknowledged that it would be insufficient to create a CCP recovery and resolution regime by merely transposing the tools and powers, in particular those in relation to resolution, of the EU Bank Recovery and Resolution Directive (BRRD). Instead the preference would be to tailor specific tools and powers more to the underlying business models of CCPs. More broadly, from an international perspective, G20 leaders have endorsed an approach developed by the Financial Stability Board (FSB) to address the risks which the failure of any financial institution (bank, financial-market infrastructure, insurance undertaking, etc.) of global systemic relevance could have on the financial system via comprehensive and appropriate recovery and resolution tools. Furthermore, the Committee on Payment and Settlement Systems/Market Infrastructures (CPSS/CPMI) and the International Organisation of Securities Commissions (IOSCO) have developed guidance on recovery plans for financial market infrastructures, including CCPs, while the FSB has issued further guidance on the application of its Key Attributes of Effective Resolution Regimes to financial market infrastructures, such as CCPs, as well as insurers. Finally, in December 2013, the European Parliament adopted an own-initiative report calling on the Commission to propose appropriate EU measures to ensure that the impacts of a potential failure of key financial institutions, most notably CCPs, could be mitigated. A proposal to create a European framework for the recovery and resolution for CCPs had been signalled in the Commission’s Work Programme for 2015, but was carried forward in order to take into account further input from the continuing international work on CCP resilience, recovery and resolution, carried out by CPMI/IOSCO, the FSB and the Basel Committee on Banking Supervision (BCBS). 2Procedural issues and consultation of interested parties 2.1Procedural issues The first meeting of the impact assessment steering group took place on 10 April 2013. The second meeting took place on 5 September 2014 and the third one on 11 March 2015. DGs involved in the steering group were ECFIN, TRADE, SG, LS, JUST and COMP. The minutes of the final steering group meeting were submitted to the Impact Assessment Board on 8 April 2015. The Board meeting took place on 6 May 2015. While a positive opinion was given, the Board recommended improving the following areas: (1) the rationale for acting at EU level, by better explaining why and how CCPs might fail and by describing what the related risks are including their cross-border dimension; (2) the option section, by better justifying the small range of alternatives considered and clarifying whether the options are different to those retained for banks;

(3) the assessment of impacts, by better explaining how significant administrative costs are expected to be, who will be affected and how by the different options, and which categories of stakeholders support which options. These have been addressed and incorporated in this final version. 2.2External expertise and consultation of interested parties Stakeholder consultation A public consultation on a possible recovery and resolution framework for non-bank institutions was carried out between 5 October and 28 December 2012. 67 replies were received. On the whole, the consultation indicated that the priority should be to develop an EU-wide recovery and resolution framework for CCPs. Respondents generally agreed that, like the BRRD for banks, an EU framework for the recovery and resolution of CCPs should, ensure continuity of their critical functions, minimise exposure to losses for taxpayers from their failure and improve legal certainty for their clearing members and clients. They recalled that this necessitated tailoring the BRRD tools to the specificities of CCPs’ business models. External expertise The Commission has gained valuable insights through its participation in the discussions and exchange of views informing the CPMI/IOSCO report providing guidance on the recovery of financial market infrastructures. The Commission has also attentively followed the work relating to the resolution of other non-bank financial institutions carried out by the FSB. On their part, in elaborating the reports proposing guidance on (respectively) recovery and resolution, both CPMI/IOSCO and the FSB asked interested parties to provide comments on their draft guidance documents and published the responses received. On the whole, these international level consultations for Financial Market Infrastructures confirm the views expressed in the Commission’s own consultation, and provide some additional feedback on the relative merits of some of the proposed policy options and resolution tools. On 22 November 2013 the Commission services held a first meeting with Member States' experts to discuss the international work being carried out by the FSB and CPMI-IOSCO. Member States agreed on the need for a CCP recovery and resolution legal framework in the EU. Further meetings of Member States' experts took place on 19 December 2014, 30 September 2015 and 27 June 2016. A summary of the meetings can be found at http://ec.europa.eu/transparency/regexpert/index.cfm?do=groupDetail.groupDetail&groupID=2392&NewSearch=1&NewSearch=1 The Commission services took account of the opinions voiced by stakeholders in preparing the legislative proposal. 3Policy context, problem definition and subsidiarity 3.1Background and context CCPs constitute the "central nervous system" of financial markets by playing a key role in managing systemic risk. In consequence, a significant amount of financial risk is concentrated in a CCP. The annual value of transactions cleared by CCPs is in the trillions of euros. For instance, the volume of centrally cleared OTC transactions at the end of 2012 was estimated to total USD 346.4 trillion, of which USD 341.4 trillion was attributable to interest rate derivatives and USD 5 trillion to credit default swaps (CDSs). More disaggregated data from end June 2015 shows that for interest rate derivatives alone, the gross outstanding notional amount was estimated to be USD 175 trillion (around 48% of notional outstandings ) and for OTC credit derivatives, the gross outstanding notional amount of USD 2.4 trillion (12% of the total amount outstanding) had been centrally cleared. In the US, the trend for centrally cleared trades has been stabilising at 80% of weekly aggregate transaction volumes for credit derivatives and 70% for single-currency interest rate derivatives, respectively since Q4 2013. Effective regulation and robust supervision of CCPs is thus essential, which is assured in the EU by EMIR. However, no system of rules and practices can preclude failure absolutely. While actual failures have been rare and have not occurred recently, those that have taken place have been brought on by vulnerabilities inherent in CCPs’ business models. These include the collection of insufficient initial margin by the CCP against the risks it is exposed to, an inability by clearing members to meet sudden large margin calls and problems relating to the ability of CCPs and authorities in grasping the build-up of the risks concentrated in CCPs and the implications of this for the wider market. Most European market infrastructures for the clearing and settlement of financial transactions were originally created to serve domestic needs. Today, many CCPs clear several product classes, from listed and OTC financial and commodity derivatives to cash equities, bonds and repos, and provide their services across national borders. However, despite the expansion and diversification of the services offered by CCPs, the EU landscape for post-trade (clearing and settlement) services continues to be fragmented along national lines, resulting in inefficiencies and higher costs for cross-border transactions. Twenty-one CCPs currently serve the securities and derivatives markets in the European Economic Area (EEA). Some serve primarily domestic markets and a single exchange, while others are present in multiple markets and serve trading venues in several EU countries. Many of the largest global banks are members of multiple CCPs, illustrating the potential for contagion. For example, 24 globally systemically important banks (G-SIBs) are members of Eurex; or the other way of looking at it is that a designate G-SIB such as BNP Paribas is a member of at least five EU CCPs. Annex VI provides an overview of the main CCPs operating in Europe and their ownership models, the values of cash securities they cleared in 2011, the classes of OTC derivatives they offered to clear in April 2014, recent trends in the increase and subsequent stabilisation of central clearing of OTC derivatives, and the memberships of the largest global banks of leading global CCPs. The ownership of CCPs has been evolving over the past decade, shifting from the traditional user-owned structure to a wider range of ownerships and models, including hybrid models where private shareholders, clearing members and exchanges share ownership. Some CCPs are still owned and governed by their members, while others are fully or part-owned by non-members, either as listed companies or as part of a group, which may itself be listed. Studies and publicly available figures suggest that CCPs that operate on a for-profit basis are very profitable. The revenue of a CCP derives from fees charged for clearing, penalties on late settlement and from earnings on collateral supplied by clearing members. Publicly available figures suggest that equity CCPs typically derive about 80% of their revenue from fees and 20% from net interest earnings. CCPs that clear fixed income and derivative instruments derive a significantly higher portion of their revenue, over 40%, from net interest earnings as the transactions based on these asset classes require a greater amount of collateral from the clearing members. 3.2Overview of legislative framework In force since August 2012, EMIR requires CCPs to observe high prudential, organisational and conduct of business standards. National supervisors are tasked with the full oversight of their activities. In response to the G20 commitment, EMIR also requires standardised OTC derivatives to be centrally cleared in a CCP. In line with international standards, EMIR requires CCPs to have adequate operational contingency arrangements, including to ensure that losses arising from the possible default of two members (i.e. a default event) can be covered by the margin of the defaulted members and a default fund, which is financed through contributions collected from the CCP's members, as well as other own resources. In addition, CCPs that are interoperable with other CCPs are required not only to collect margin from their members to cover against risks on their platform, but also to exchange margin between each other. A predefined “waterfall” of financial resources determines the order in which margins, default fund contributions and other resources, such as shareholder equity, are called upon to absorb losses. A CCP typically reinvests the contributions collected from its members. However, any reinvestment must be available promptly and therefore must be made in highly liquid financial instruments. EMIR accordingly sets out limitations on the types of investments that a CCP can make. It also sets out the specific capital requirements applicable to CCPs that aim to, inter alia, ensure that a CCP is adequately protected against risks not covered by its default waterfall (i.e. other (non-default) events). These include business, legal and operational risks. The resources ought also to enable the CCP to be wound-up or restructured over an appropriate time span; however, these are taken to be used primarily for the purposes of a gradual wind-up due to general business losses rather than for constituting adequate reserves to cover losses in a scenario where losses arise quickly (for instance in relation to, for example, cyber-attacks, fraud or investment losses).

Recognising the systemic role of CCPs, the BRRD also provides safeguards that seek to avoid the failure of an EU bank or EU investment firm, typically the clearing members of CCPs, resulting in unmanageable losses for CCPs. For example, these institutions would have to continue to honour, during their resolution, their obligations towards CCPs even as obligations towards other creditors could be suspended.The institutions’ obligations to CCPs and other financial market infrastructures maturing in less than seven days are also excluded outright from bail-in to protect their functioning. Beyond this, while CCPs are not excluded from potentially suffering losses on their outstanding exposures in relation to a failed bank, banks’ obligations to CCPs and other financial market infrastructures are mentioned explicitly among the liabilities which could be exempted from bail-in for overwhelming financial stability reasons. As a result, the likelihood of CCPs' incurring large losses in the event of the failure of an EU clearing member bank or EU investment firm is substantially reduced. However, certain CCPs, in particular those which have non-EU clearing member banks as well as those which clear commodity trades, might have non-financial entities as clearing members (such as energy companies), whose potential failure would not be fully subject to these BRRD safeguards. Recovery and resolution measures for CCPs aim to complement, not duplicate, aspects of the existing EMIR framework. They would further bolster the preparedness of CCPs to mitigate financial stress, provide authorities with further insight into the operations of the firms within their jurisdictions and provide them with a set of powers to deal with the declining health of a firm in a coordinated manner and, where necessary, resolve the firm, restoring its critical functions preserving financial stability, and minimising the cost to taxpayers. The authorities would only resort to resolution powers, if normal insolvency proved to be insufficient to meet these aims. Box 1 –Recovery and resolution regime for CCPs in the EU No Member State has yet developed a full national regime for CCP recovery and resolution. However, the United Kingdom (UK), Italy, France and Germany have partial regimes, where their effectiveness is uncertain. The UK Through a series of amendments to existing legislation between 2011 and 2013, the UK has introduced a number of measures to recover and resolve CCPs established in the UK. They have required CCPs to draw up recovery plans and establish loss allocation provisions, which would be exercised once the default resources required under EMIR are exhausted . The CCP supervisor – the Bank of England – may exercise an overriding power of direction for broader financial stability reasons (beyond compliance with EMIR and UK prudential requirements) which might be used, for example, to direct a CCP not to use its loss allocations to tear up all contracts in a service. Furthermore, during the resolution of the CCP, the resolution authority – a functionally separate area of the Bank of England – would be availed with the ability to sell part or the whole of the CCP business to a solvent purchaser and to establish a bridge institution. A safeguard exists regarding the financial interests of those affected by transfer orders made in relation to CCP resolution, whereby HM Treasury (the finance ministry) may make a compensation order in exceptional circumstances relating to CCPs. UK legislation establishes that the resolution objectives are, with no order of priority, to maintain the continuity of CCP clearing services; protect public funds; avoid, to the extent possible, interfering with property rights; protect and enhance the stability of the financial systems of the UK; and protect and enhance public confidence in the stability of the financial systems of the UK. The use of any resolution power is deemed to be a last resort measure, but can be effected prior to insolvency. In this light, prior to their use, the resolution authority would have to determine that: (a) a CCP is failing, or likely to fail, to satisfy the recognition requirements; and (b) having regard to timing and other relevant circumstances, it is not reasonably likely that (ignoring the resolution powers) action will be taken by, or in respect of, the CCP that will enable the CCP to maintain the continuity of any critical clearing services it provides while also satisfying the recognition requirements. HM Treasury would have to further determine that it would be in the public interest to place the CCP in resolution rather than insolvency. The UK recovery and resolution regime for CCPs are in line with the FSB key attributes; however, to be fully compliant loss absorption measures would need to be implemented. Italy Italy, in 2007, extended their resolution framework for financial market infrastructure to CCPs, which includes regimes for Special Administration (with the purpose of continuing the CCP) and for Compulsory Administrative Liquidation (i.e. winding up). A CCP could enter into the Special Administration regime (SAR) if there have been serious irregularities in the management of the CCP and / or serious capital losses. Whereas, a CCP could be placed under the Compulsory Administrative Liquidation regime (CALR) if the Bank of Italy has withdrawn its authorisation or the courts have declared the CCP to be insolvent. As part of this regime, the operations of the CCP are frozen, all CCP payments are suspended, and contacts are terminated. The Bank of Italy, the designated resolution authority, may permit operations to continue on a temporary basis. The Bank of Italy, the designated resolution authority, in both cases would have a wide discretion of powers. It could, for example, direct the activities of the special administrator or commissioner appointed under the SAR and require that it has to provide prior consent for any initiative taken by the liquidator. However, as initial margin is bankruptcy remote it would not be touched in either regime. Other powers include, the ability to enforce cash calls as well as any previously agree position allocation mechanisms (such that non-defaulting clearing members take on the positions of the defaulted clearing member(s)). France and Germany In France and Germany, CCPs are required to have a bank licence. As such, their authorities would be able to exercise the powers available to them under the BRRD. However, as all BRRD tools would not be suitable for the resolution of CCPs the regime would not be effective. 3.3Problem definition This section outlines the problems posed by the absence of appropriate powers and tools to prevent and mitigate the failure of CCPs from jeopardising financial stability .



Problem tree Authorities

Why is there need for action? CCPs are market infrastructures that improve the efficiency of financial trading through, for example, addressing information asymmetries and reduce complexity, as well as mitigate and manage counterparty, liquidity and operational risks. This proved particularly valuable during the financial crisis; while a significant number of defaults could be observed in bilaterally traded OTC derivatives, this was not the case for centrally cleared contracts. As a direct result of regulatory requirements, like EMIR, the importance of CCPs further expands. The mandatory centralised clearing of OTC derivatives should mitigate the overall risks linked to these derivative transactions, which have more often than not taken place on a bi-lateral basis, and should consequently result in net benefits of roughly 0.12% of EU GDP per year.

Given the centrality of CCPs to the financial system, the increasing systemic importance of CCPs gives rise to concerns. As such, CCPs have themselves become a source of macro-prudential risk, as their failure could cause significant disruption to the financial system and would have systemic effects. For instance, mass, uncontrolled termination and close out of contracts cleared by CCPs could lead to liquidity and collateral strains across the market, causing instability in the underlying asset market and the wider financial system. Like some other financial intermediaries, CCPs are also potentially susceptible to “runs” due to clearing members losing their confidence in the solvency of the CCP. This could create a liquidity shock for the CCP as it attempts to meet its obligations to return the principal collateral (i.e. initial margin). To counter this, some of their members and other participants (i.e. the clients of clearing members) note that greater transparency regarding, for instance, the size of the margin pool at the CCP and the other elements of CCP default waterfalls would reduce their vulnerability to destabilising runs, as such transparency would allow clearing members and clients to better assess their exposures at all times. CCPs or their clearing members may also face acute liquidity strains during periods when credit or funding markets are disrupted. A CCP trying to liquidate a defaulted clearing member’s initial margin (i.e. principal collateral), to for example meet the variation margin obligations of the defaulted clearing member, under these conditions might have to sell it at fire sale prices, thereby exacerbating the losses imposed on the CCP and perhaps even resulting in a CCP default, as it is unable to meet the obligations of the defaulted member (which it has assumed), even with the resources available to it under the default waterfall. Fire sales can dislocate and create further panic in already stressed asset markets, thereby creating losses for and imposing costs on other market participants. Similarly, a CCP might not be able to obtain credit via private transactions, or may only receive it at punitive rates (or haircuts). The increasing systemic importance of CCPs can be categorised in terms of: (i) the increasing amounts centrally cleared, (ii) concentration risk and (iii) contagion effects. (i) Increased volumes centrally cleared transactions: as intended by regulators, large shares of OTC derivatives transactions are already centrally cleared (see section 3.1 and annex VI). (ii) Concentration risk: the concentration risk associated with a CCP arises almost as a natural consequence of its features, namely by becoming critical nodes in the financial system. The notional amounts referenced above are cleared through a small number of available CCPs. For instance, in the EU, six CCPs exist for credit products and fifteen exist for interest rate products. In the US, there are five and nine authorised CCPs for these two product types, respectively. The degree of concentration also depends on the structure of the underlying markets. Another factor is that due to the complexity of derivatives markets, a limited number of CCPs (from a cost perspective) specialise in dedicated products; which in turn tends to add to concentration of the sector. Publically available data on clearing members per CCP appear to confirm this picture. For example, Bank of England supervised CCPs have between 18 and 98 clearing members, depending on the product type. (See also annex VI, part E that shows which G-SIBs are members of which CCPs.) (iii) Direct and indirect contagion: the expansion of the use of central clearing will fundamentally alter the topology of the global financial system, with CCPs becoming even more crucial nodes of activity, where all major financial institutions will be interconnected via their (direct and indirect) linkages to CCPs. Central clearing thus reconfigures interconnections and counterparty risk between systemically important financial institutions in favour of centralised risk management such that these risks are mutualised and offset against each other during normal day-to-day practices. In this context, the failure of a CCP could result in widespread financial contagion as a financial problem in one institution is propagated to many other institutions via their linkages to the CCP's different contagion channels. CCP failures A CCP may enter into financial distress as a result of (i) clearing member default (i.e. default events) or (ii) due to business, legal or operational reasons, such as losses on the CCP’s investments, or due to fraud or cyber-attacks (i.e. other (non-default) events). Failures of significant CCP clearing members have happened several times during the last 25 years. CCPs have had to manage defaults of Drexel Burnham Lambert (1990), Barings (1995), Griffin (1998), Enron (2001), Refco (2005), Lehman Brothers (2008) and MF Global (2011). Going back further in history, evidence can also be found that CCPs had been placed in insolvency, even before OTC derivatives were required to be cleared by CCPs, due to a combination of improper risk management practices and the default of CCP participants. For instance, Caisse de Liquidation (Paris) in 1974, the Kuala Lumpur Commodity Clearing House in 1983 and the Hong Kong Futures Guarantee Corporation in 1987. A near failure was experienced with the Chicago Mercantile Exchange (CME) in October 1987. (See annex X for further details on default events.) The failure of these CCPs, which happened during times where financial markets were not as globally interconnected or complex as now, led to, for example the closure of the sugar market for two years and government bail-outs. Current risk mitigation techniques As mandated by EMIR, ESMA is currently developing a framework for stress testing EU CCPs. These tests will examine, inter alia, the limitations of each CCP's default fund protection, to identify the scenarios under which a CCP's default resources would be exhausted. This data has not been available at the time of drafting this impact assessment; hence it has relied on external studies. The already quoted October 2014 Financial Stability Paper by the Bank of England examines whether the "cover 2" requirement (the EMIR requirement whereby the CCP should have sufficient resources to meet the default of the largest one or two clearing members) remains prudent enough if the number of members of a CCP or the distribution of exposures among members changes. It uses a market-consistent approach, which is based on actual stressed losses over initial margins and default estimates, as well as an analytical approach, based on theoretical loss distributions. Both methods suggest that "cover 2" is a sufficiently prudent for most risk distributions found in practice. However, the requirement might represent a significantly weaker safety net if the distribution of exposures among its clearing members becomes more uniform. For these distributions, the paper concludes that higher financial resources might be needed to ensure robustness of CCPs. Simulations from CCPs, based on their own exposure data, demonstrate that such scenarios under which all defaulters' funded resources would be exhausted go beyond relevant historical stress events, including the recent financial crisis. Hence, this impact assessment notably considers proposals for resolution tools which are different and independent from increased, EMIR pre-funded financial resources to address these tail-risk events cost-effectively. Further quantitative analysis of potential losses and their effects could be possible in the future once the ESMA stress tests conclude and CCPs publish further data on their default waterfalls as per requirements issued by CPMI-IOSCO . Stakeholder views Respondents (a mix of CCPs, clearing members and clients) to the Commission’s consultation agreed that CCPs are systemically relevant as they are critical financial market infrastructure, implying the need for effective recovery and resolution arrangements that are consistent with the FSB globally agreed principles. The implementation of the G20 requirement for standardised OTC derivatives to be centrally cleared was recognised as a compelling argument in favour of taking action to address this source of systemic risk. Almost all stakeholders (with the notable exception of some clients of clearing members) agreed that, to safeguard financial stability, the continuity of key operations of CCPs should be the priority. All agreed that the costs of a CCP failure should not fall on taxpayers. Many considered that while it will be critical to ensure that recovery and resolution arrangements for CCPs are credible and robust, these should not place excessive burdens on members or their clients to cover potentially significant liabilities arising from the default of a major clearing member (i.e. default events) or, even less, for those arising from internal CCP risk management errors (i.e. other (non-default) events). The benefits of central clearing for the overall stability of financial markets are beyond doubt. The G20 aim of greater CCP-clearing to mitigate the systemic risk inherent in otherwise poorly overseen networks of opaque bilateral transactions is not put into question. Empirical cases of CCP failure are few but do exist. In any case, the above scenarios of CCPs encountering and spreading overwhelming financial difficulties should not be neglected, in particular in a world where financial markets are globally interconnected. The failure of a CCP would expose clearing members and their clients to potentially large losses and a cessation of CCP services could deprive market these participants of basic functions, thereby leading to a possible shutdown of entire markets (as was with the case of the failure of Caisse de Liquidation), with knock-on effects even on markets not directly affected and spill-overs for the real economy. Benefits of the proposal It is difficult to extrapolate these potential direct and indirect losses from a CCP failure in the abstract. However, it can be assumed – as a minimum – that the net benefits which have been estimated to flow from greater CCP-clearing of OTC derivatives (0.12% of GDP) would be foregone. No firm publicly available estimates exist for the additional losses and costs which could result from contagion and the uncertainty caused by a CCP failure, but the impact of one could be comparable to the costs of a systemic banking crisis. The present value of output losses in atypical banking crisis has been estimated to be 60% of one year’s GDP. The sections and sub-sections above outline some thoughts on losses and impacts in a scenario of CCP distress or failure, against which the loss allocation mechanisms of a recovery and resolution regime could be assessed and justified, in particular for such a tail-event. They set out that, in the rare event of such extreme losses, rather than relying on higher capital and collateral requirements in a precautionary but arguably uneconomical way, recovery and resolution tools would be useful means to spread these losses in an equitable way and to safeguard financial stability. Albeit difficult to quantify, the proposed recovery and resolution framework for CCPs would deliver the following three main goals, similar to those identified in the case of banks.

1.Overcoming the suboptimal preparation: CCPs are subject to stringent prudential requirements pursuant to EMIR. However, there is no uniform and enforceable standard requiring CCPs and authorities to prepare contingency arrangements and plans for orderly recovery and resolution to avert crises at CCPs from threatening financial stability, including for situations where prudential requirements would prove insufficient to cover the increasing financial risk concentration in CCPs in the event of failure. As a result of this absence of comprehensive recovery and resolution planning, CCPs and authorities are not fully prepared for a potential CCP crisis, and as such do not have the necessary powers to improve resolvability ex-ante in case of failure, and have few means to effectively secure the continuity of CCPs’ critical functions in such a scenario. The result is that CCPs and their authorities are sub-optimally prepared for extreme crises and a legally and operationally deficient framework to allow for effective intervention when necessary. 2.Enhancing the currently inadequate means of early intervention: Member State authorities have variant powers to intervene in the operation of CCPs before terminal problems crystallise, either before or during the CCP's default management process. As a result, authorities may take very divergent, ad hoc, uncoordinated measures and at different times in their efforts to restore the viability of the CCP or to prevent actions taken by the CCP that could compromise financial stability. This suboptimal intervention framework means that avoidable failures or measures counter to overall financial stability may occur. Through, for example, defining specific tools that could complement the CCP’s default waterfall and their criteria for use or providing authorities with powers that require changes to the CCP’s management or targeted changes to specific collateral arrangements which may be causing problems, some failures could be averted. 3.Introducing an efficient framework for resolution: most Member States authorities do not have either the clear jurisdiction or a comprehensive framework to resolve a CCP. Their absence, as learnt through the pains of the recent banking crisis, can result in some authorities being unable to take the required measures or others choosing to intervene at different times, leading to disorderly and misaligned national approaches, legal uncertainties and ineffective resolution of CCP, in particular for those with operations in multiple jurisdictions. Differing and uneven measures would also lead to frustrating efforts to stabilise the critical operations of a CCP and critically impair its functioning, jeopardising financial stability and the integrity of the Single Market. The absence of a harmonised framework would also mean that the owners and creditors (including the clearing members and clients) of CCPs contributing unevenly to the costs of resolution, where some might not bear any loss as States intervene to continue critical functions. Other could fare better off than if the CCP gone into insolvency, but most would probably be worse off. Without a structured resolution framework, they would also be subject to a high degree of uncertainty, which in turn could lead to lack of market confidence, contagion and other secondary effects caused by CCP failure. Furthermore, the owners and creditors could be exposed to differential treatment across borders and in uncoordinated attempts by national authorities to minimise losses for some groups of stakeholders; undermining the integrity of the Single Market. Without greater clarity of their potential exposures, clearing members’ incentives to monitor the risk they bring to the CCP would be distorted. On the whole, this constitutes a suboptimal framework to tackle the failure of a CCP, resulting in inefficient markets, as well as an unfair and uneven allocation of losses and costs among CCP owners and creditors and taxpayers, and which might even compel authorities to deploy public funds in differing ways to continue critical functions and to fill any funding gaps or provide for compensation. Taken together, the absence of clear and harmonised provisions for preparation, early intervention and resolution in case of CCP failure would impose significant socio-economic costs. The uncertainty over available means to tackle a CCP crisis generates risks for financial stability, can cause damaging levels of fragmentation for the internal market and result in acute moral hazard if there is no alternative to taxpayer bailout. This uncertainty is also evident in stakeholders’ disparate views. While authorities, CCPs, clearing members, and their clients generally agree that the threat of CCP-failure is a major problem, they do not all agree on how best to address it and how costs should be distributed in order to preserve financial stability (see section 6.6 and annex XI part B), as each grouping considers that the other should bear any cost. 4The EU's right to act and justification EU financial markets are open and integrated. CCPs are able to operate and provide services cross-border. In the process, they link multiple financial actors, counterparties (i.e. clearing members, typically large banks) and clients throughout the Single Market. Due to this advanced and multi-layered cross-border integration of the financial sector, a resolution and recovery framework for CCPs is needed that mirrors the integration of the business. Only EU action can ensure that CCPs and their clearing members are subject to adequate and effective intervention to mitigate or address a crisis situation, as well as adequate safeguards. The recent crisis demonstrated how ill-equipped Member States, their authorities and central banks were in dealing with preventing and subsequently addressing the crystallisation of risks in banks and, in particular, in a coordinated manner when dealing with a bank with operations in more than one Member State. A number of governments had to enact emergency legislation to equip their authorities with powers to deal with the disorderly failure of systemic banks or had to take such banks into public ownership to stem contagion. Central banks were also compelled to pump liquidity into the system to prevent further contagion due to the whole system seizing up. Without a uniformed approach (across the EU and globally, brought about by the FSB key attributes to effective resolution regimes and the EU bank recovery and resolution directive), as well as political drive to rule out any further use of taxpayers monies for public bailouts (as far as possible) (including through the adoption of the BRRD), market fragmentation may have exacerbated. From this hindsight, it is clear that the current tools available to Member State authorities, if any, are inadequate to deal with CCPs that face significant distress that could compromise the viability of the entity. Where they exist, they are limited to the entity’s internal arrangements or are nationally based. The divergent approaches, by which CCPs and authorities mitigate or tackle the problems within the CCP facing financial distress or on the verge of failure, could ultimately lead to the disruption of critical functions for the economy and wider financial instability. EU level action is therefore necessary to adequately equip Member State authorities with tools and powers, that would have enforceability across the Union, to deal with the failure of CCPs located within their jurisdictions, and to ensure effective communication amongst all relevant authorities (e.g. the supervisors of the clearing members and any associated trading venue), whether they be in the same Member State or another. This would, for example, reduce the possible arbitrary effects when a CCP has clearing members in Member States other than the Member State where it is established. As a CCP fails, each national authority of the constituent parts of a CCPs business (e.g. the clearing member and the trading venue) would likely pursue different objectives. Consequently, Member State authorities and market participants would not be guaranteed that critical problems arising from a crisis situation can or will be solved fairly, effectively and expediently. EU-level action is warranted also for CCP failures that may not have direct cross-border effects, but where harmonisation would mitigate possible level playing-field and competition concerns arising from the prospective and actual national handling of crises arising from a CCP failure. For example, if national regimes were to legislate differing resolution regimes, with a varying degree of potential state intervention with public funds, those which are less costly on the CCP and the clearing members (i.e. those which would unlikely eradicate any degree of state funds being used should the CCP fail) would attract more business to the CCPs in that jurisdiction. Additionally, without EU-level actions, some jurisdictions may not adopt any form of a recovery and resolution regime, and due to the integration of the Single Market, the failure of a CCP in a jurisdiction without such effective tools would likely resonate throughout the Union. However, while a CCP may primarily serve its domestic market, it is unlikely that all of its clearing members and their clients would be located in the same Member State. Therefore, there will always be a cross-border dimension if a CCP were to fail. Some Member States have already enacted legislative changes specifically to avert potential solvency problems in CCPs or as part of broader resolution regimes for the financial sector. However, the cross-border effectiveness or their overall adequacy is questionable. The majority of Member States do not have specific or comprehensive resolution regimes for CCPs. The inability of Member States to take control of a failed CCP and resolve it effectively would undermine Member States' mutual trust and the integrity of the Single Market. The uncertainty over how the failure of key market infrastructures could be managed in the absence of an EU-wide framework is cited as one reason for the lag in the pace of integration in Europe’s capital markets. Clarity on the content and process of resolution measures is thus a necessary step to accompany the existing prudential framework applicable to these entities and progress toward a deep, single capital market. As mentioned above, the experience with bank failures in different Member States underlines how problems at systemic financial institutions can fragment the Single Market into national economic zones. Market perceptions and biases in favour of entities located in jurisdictions with relatively stronger implied backing by the state can cause competitive distortions and arbitrarily influence costs for businesses depending on their geographic location and the perceived appetite of, or necessity for, a Member State to pre-emptively ring-fence assets, liquidity or capital to minimise cross-border exposures. By extension, the same threat provides a basis for EU action to address the failure of a CCP. As in the case of the BRRD (and SRM), Article 114 of the Treaty on the Functioning of the European Union provides an appropriate legal basis for corresponding initiative for CCPs. 5Objectives The general objectives of the initiative for a recovery and resolution framework for CCPs in the EU are: Objective 1: safeguard financial stability and confidence in CCPs, ensuring the continuity of essential financial services and minimising loss of value and contagion of problems to clearing participants (i.e. clearing members and their clients) and other market participants (such as linked FMIs); Objective 2: minimise losses for society as a whole and in particular for taxpayers, while calling upon shareholders and clearing participants in CCPs to contribute to the costs of recovery and resolution in a fair way, reducing moral hazard; and Objective 3: strengthen the Single Market for services provided by CCPs, while maintaining a level playing field (i.e. comparable conditions for all players to compete in EU financial markets) and further harmonising the level of protection of clearing participants. In relation to the problems identified in section 3.3 and in order to achieve the three main objectives above, the specific and operational objectives are the following. All five are crucial in overcoming the identified problems and to reach these objectives comprehensively and in a mutually supportive fashion. Overall Problems Problem drivers Operational objectives Specific objectives Disorderly failure of CCP, spreading contagion and risking taxpayer bail outs Financial risk concentration in CCPs, including from increasing interconnections between all major financial institutions and CCP, which may threaten orderly functioning of financial markets if a CCP were to default Increase the transparency of how a CCP might fail and the allocation of losses across its stakeholders. Make proportionate ex-ante (legal, operational, structural) changes to reduce the likely cost of failure. Establish an EU recovery and resolution framework that promotes efficient markets and realign risk and reward, strengthening the Single Market

Preparation and prevention Problems Problem drivers Operational objectives Specific objectives Suboptimal level of preparedness of supervisors and CCPs for potential severe crisis situations, including tackling impediments to effective action CCPs and authorities unprepared for potential crisis situations affecting CCPs Ensure effective contingency planning by CCPs and authorities and enable authorities to remove ex-ante any legal, operational or structural barriers to recovery or resolution Increase preparedness of relevant authorities and CCPs for crisis situations Early intervention Problems Problem drivers Operational objectives Specific objectives Sub-optimal early intervention arrangements for supervisors Supervisors unable to avert a crisis situation from crystallising Empower all CCP supervisors with a set of common powers and tools to intervene at an early stage to abate the financial distress affecting the CCP and restoring its long term viability Improve early intervention arrangements for supervisors Inconsistent use of early intervention powers, where they exist Provide all supervisors with a realistic triggers for early intervention powers Uncertainties about the time required to ensure solvency of the CCP and continuity of, at least, its critical functions in emergency situations Shorten time period to ensure solvency and continuity of CCPs in emergency situations Resolution Problems Problem drivers Operational objectives Specific objectives Inefficient CCP resolution process and suboptimal outcomes Uncertainty for owners, creditors and participants of when a CCP would be placed into resolution Provide authorities with clear and reliable resolution triggers Ensure resolution of CCPs in a timely and robust manner to limit contagion and eliminate legal uncertainties Owners, creditors and participants treated differently in each jurisdictions due to divergent or lack of effective resolution tools & powers Empower all resolution authorities with a minimum harmonised set of resolution tools and powers to resolve CCPs, eliminating legal uncertainties Lack of authorities responsible for CCP resolution Ensure that national interest of resolution authorities does not jeopardise resolution of cross border CCP or one that offers its services across borders. Reduce market fragmentation and ensure that all stakeholders (owners, clearing members and clients) are treated fairly regardless of their location Misalignment between national responsibility of authorities and cross-border nature of the industry Financing and cost/loss allocation Problems Problem drivers Operational objectives Specific objectives Potential use of public funds in crisis situation to absorb the losses (and recapitalise the failing institution), if available. National systems cannot ensure an optimal and even level of protection of financial stability across Member States Taxpayers, not owners or creditors of the CCP, pay for the cost of the entities failure Develop appropriate private financing and cost/loss allocation arrangements for CCP resolution Develop appropriate cost/loss allocation arrangements for financing CCP resolution from private sources that provide optimal and even level protection for all Member States (in line with other prudential measures and national insolvency rules) Divergent national policies concerning financing of crisis situations (where available) Develop and calibrate optimal cost/loss allocation arrangements for financing CCP resolution across EU Conflicting interests of Member States concerning financing of crisis situations Align national interest with EU-wide interest in financial and cost/loss allocation arrangements 6Principal policy options, Comparison and analysis of the impacts 6.1Baseline scenario Maintaining the status quo would mean retaining the scenario described in the problem definition above. EU prudential requirements applicable to CCPs do not require the preparation of plans for the effective recovery and/or resolution of CCPs. Therefore, despite the global guidance provided by CPMI/IOSCO on recovery of financial market infrastructures and by the FSB on resolution regimes, there is a clear risk that neither CCPs nor authorities would be adequately prepared for their potential failure. Therefore, notwithstanding that CCP failure has thus far been a rare occurrence, if no EU regime for the recovery and resolution of CCPs is in place, either disparate national regimes or normal insolvency law would apply to CCPs where their viability and financial strength are compromised, through for example the materialisation of risks laid out in annex VIII. As such the continuation of the critical services provided by CCPs would not be ensured in case of extreme events which give rise to large losses for the CCP. Due to the specific features of CCPs, and their interconnectedness with the wider markets, this could lead to severe systemic disruptions and threaten financial stability. In this respect, it is again necessary to take into account that the importance and risk exposure of CCPs will increase in the coming years due to the implementation of the OTC derivatives clearing obligations. Moreover, the distress of a CCP could quickly produce contagion effects via its users to other financial market players and to other CCPs with which it is interlinked. Furthermore, avoidable failures of CCPs may materialise because the relevant authorities lack comprehensive means to intervene in the operation of CCPs before terminal problems crystallise. As a consequence of the above, if no action at EU level is taken, it cannot be excluded that in order to prevent a CCP failure from compromising financial stability, taxpayers' money would have to be used to support their operations and cover incurred losses. 6.2Possible options to increase preparedness of supervisors and CCPs for crisis situations

These policy options involve how best to ensure that, beyond the requirements of EMIR, authorities and CCPs prepare sufficient contingency plans for diverse crises. Such options are in line with the G20 endorsed internal standards of the FSB. Policy option Description 1. No policy change The baseline scenario applies 2.Development and maintenance of recovery plans by CCPs CCPs would have to adopt recovery plans setting out the recovery measures they would take in extreme circumstances that could threaten their viability and financial strength. This could inter alia include adding an additional financing layer to the default waterfall under EMIR to cover losses exceeding those predefined resources. Recovery plans would constitute a regularly updated preparatory tool against diverse and foreseeable threats to the overall viability of the CCP. They would include the following: (i) identification of the critical services; (ii) identification of stress scenarios that may prevent the CCP from being able to provide its critical services as a going concern; (iii) identification of the criteria, both quantitative and qualitative, which could trigger the implementation of all or part of the recovery plan; and (iv) identification of the recovery tools and the tools to address structural and operational weaknesses. Authorities would periodically assess the adequacy of the plans. On the basis of the assessment, authorities may require the entity in question to correct deficiencies. 3. Development and maintenance of resolution plans and resolution strategies and operational plans by the resolution authority (separate from but in addition to recovery plans) Authorities would have to maintain up-to-date resolution plans and that would include the identification of a resolution strategy for the CCP, taking account of the recovery plan and of on-going resolvability assessments by the authorities. Resolution strategies would facilitate the effective resolution of the entity in a way that ensures continuity of its critical functions and winds its remaining services down in an orderly way, following the transfer of its critical functions to another entity. Authorities would test the effectiveness of their resolution plans as part of comprehensive contingency arrangements, and any identified impediments that are significant to resolvability should then be removed. Option 2: the development of recovery plans will form a key component of a CCP's risk management. They will increase the level of due diligence undertaken by CCP as part of their day-to-day operations and will provide the CCPs with a strategy to mitigate financial distress when it arises, either from member-defaults or other (non-member) defaults. Based on the information and procedures set out in the plans, the CCPs would be able to restore their financial health, enabling the continuation notably of their critical services, when their viability as a going concern is threatened. The CCP would test the robustness of the recovery plans against various scenarios (such as uncovered losses arising from defaults among CCP clearing members, liquidity shortfalls and inability to meet margin payments, capital inadequacies, or a combination of the scenarios), revealing any obstacles to recoverability that would be need to be removed. This could, for example, mean the CCP establishing additional private contractual agreements to ensure that recovery measures can be enacted in a timely manner. Through this process the resilience of CCPs would be enhanced, providing further confidence that CCPs would be able to function effectively even under extreme stress. As such, the recovery plans would complement EMIR prudential and other organisational requirements. Within the recovery plans, CCPs would identify their critical functions and services, list appropriate recovery measures they may undertake and, based on different scenarios of stress (complementing and going further than the stress test currently conducted by the CCP and the relevant authorities), set criteria that would trigger the implementation of such measures. However, no measure should assume recourse to public funds or extraordinary support from central banks. The adequacy of the recovery plans, including the governance procedures, would need to be periodically assessed (at least on an annual basis or where there has been a material change to the organisational structure of the CCP) by its supervisory authorities, which also need to have the necessary powers to ensure that any deficiencies would be corrected. Where several different authorities are concerned, for instance because a CCP’s operations are systemically important to multiple jurisdictions, close cooperation between the relevant authorities would be necessary. Option 3: Resolution plans (separate from but in addition to recovery plans) would become relevant for a failing CCP, if the recovery measures taken by the CCP were unable to return it to viability within a reasonable timeframe or the proposed recovery measures would have likely jeopardised financial stability. Under these circumstances, the resolution plans would enable resolution authorities to respond in a rapid and decisive manner to the failure or likely failure of a CCP, thereby potentially substantially reducing the broader economic and social cost that would arise in the event of a failure. Resolution plans would also signal to the market that authorities will take all the available steps to avoid rescuing systemic entities through publicly funded bail-outs, and thus counter any perception that a CCP is too big or too complex or too interdependent to fail. The withdrawal of any implicit guarantee of state support should, in turn, incentivise sound risk management within the CCP and foster stronger market discipline in ensuring that risk management of the CCP is sound. As part of the resolution planning process, resolution authorities would develop strategies based on the information received from the CCP (and its competent authorities if different) on how – in the most effective but least burdensome way – to preserve and continue the critical functions of the CCP during a resolution, utilising the tools set out in the later sections hereunder. These strategies would then be tested against various scenarios of stress, thereby identifying potential obstacles to resolvability, which could for instance relate to the CCP's structure or operations or loss absorption features. The CCP and the relevant authorities would take steps to reduce the complexity and costliness of resolution but these should take account of, amongst other things, the likely effects on the soundness of operations, the functioning of markets, the provision of liquidity and the incentives on affected parties such as the direct (clearing members) and indirect participants (clients) of a CCP. Increasing the resolvability of a CCP would reduce implicit state support for those CCPs that are too complex to fail, minimising moral hazard and forcing entities to operate more prudently. Preferred options and analysis of their overall impacts in meeting the objectives The preferred options are options 2 and 3, thereby introducing requirements for CCPs to draw up and maintain recovery plans and for the resolution authorities to draw up and maintain resolution plans that set out the resolution strategy for the CCP, with neither assuming recourse to public funds or extraordinary support from central banks. These would complement other steps in terms of greater supervisory oversight and regulatory requirements (including stress tests), and would help CCPs and authorities in different phases of an evolving crisis situation. Importantly, they should consider all types of failure a CCP might encounter (i.e. a member default or other (non-default) events). These plans are key requirements under the FSB key attributes of effective resolution regimes for systemic institutions and form part of the Principles for Financial Market Infrastructures ('PFMI'). The introduction of such statutory planning requirements, which are also required for banks as part of the BRRD, would contribute to a level European and global playing field, generating benefits relating to strengthened risk management and resilience of CCPs. More broadly, recovery and resolutions plans would enable all relevant actors to have a better understanding of, amongst other things, the CCP's critical functions, legal status, risk profile (including the scope and complexity of its activities) and interconnectedness. This would enable the CCP and their authorities to react in a quicker, more decisive and more effective manner to mitigate any ensuing distress in the CCP or to prevent financial stability repercussions. Shareholders, clearing members and their clients would also gain greater understanding of, for example, how financial distress in a CCP could affect their ownership rights of the CCP and how any uncovered losses during recovery (and resolution) might be absorbed by their posted assets and positions. In turn this should incentivise greater market discipline, reducing the likelihood that recovery (and resolution) measures would need to be used. In a situation that threatens a CCP's viability and financial strength, the CCP and authorities would be better prepared to take the necessary action to prevent its failure or where necessary ensure its orderly resolution. The development and continuous maintenance of recovery and resolution plans will place compliance and administrative burden on some of the CCPs. Additional costs could in particular arise where CCPs need to train existing or hire additional staff and/or invest in IT or systems to develop recovery plans. The corresponding costs for banks to meet these requirements were estimated to be in the millions for the largest institutions and in the thousands for smaller entities. However, as CCPs are organisationally less complex compared to banks the overall upfront costs for CCPs should be less. Again, as the planning requirements would be proportionate to the structure of the CCP – for instance, CCPs with more product lines or complex products would likely require more planning –the cost would be proportionate to the complexity of the business model of the CCP. Furthermore, with the overall positive effect for financial stability derived from the plans, it can be considered that the overall benefits of developing and maintaining recovery and resolution plans for CCPs would outweigh any compliance and administrative costs. In a similar vein to the powers provided under the BRRD, in cases where CCPs do not take adequate steps themselves to remove the identified obstacles to resolvability, authorities would need statutory powers to improve a CCP's resolvability. This could for example include powers to require CCPs to change their business practices, structure or organisational procedures. It is not possible to estimate the cost of the requirement in the abstract, as the application of these powers would be based on a CCP's individual resolvability assessment and would vary on a case-by-case basis. Any associated costs should, however, be seen against the benefits of authorities being able to resolve CCPs in a way that maintains financial stability and transferring the costs, which otherwise would be borne by taxpayers (through public bail-outs - should the CCP fail), to the private sector. Any possible restructuring of a CCP should have lower overall economic costs in comparison to a large bank, as they have less complex structures. Feedback from CCPs suggests, at a general level, that they do not oppose the introduction of these powers, but they might challenge the case-by-case assessments of any potential shortcomings. In this light, authorities would need to justify that the exercise of any power is in the public interest and that the fundamental rights of the CCP's shareholders and management have not been unduly impinged. For instance, this could mean demonstrating that the measures are proportionate to the systemic importance of the CCP and the likely impact of the CCP failure on financial stability if the obstacles are not removed. CCPs should further have the right to appeal. Taken together, options 2 and 3 would therefore represent clear benefits in terms of meeting the objectives of maintaining financial stability and minimising losses from the failure of a CCP for society as a whole. A strengthening of the Single Market would be achieved by ensuring a level playing-field as to the applicable requirements and, in case of failure, of how well the cooperative arrangements foreseen in the plan worked in practice. In terms of the specific objectives in section 5, the options are assessed to have strongly positive impacts as per the table below.



Table 1. Comparison of policy options in section 6.2 against effectiveness and efficiency criteria EFFECTIVENESS EFFICIENCY (cost-effectiveness) Objectives Policy option Objective 1 Increase preparedness Objective 2 Effective early intervention Objective 3 Timely and robust resolution Objective 4 Financing and cost allocation Option 1 No policy change 0 0 0 0 0 Option 2 Recovery plans ++ ++ ++ ++ ++ Option 3 Resolution plans ++ ++ ++ ++ ++ Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable 6.3Possible options to improve early intervention arrangements for authorities In the event that a CCP is experiencing financial stress, the authorities could be provided options for early intervention. Early intervention would occur already in or even before the recovery phase of the CCP. These options, which are not dis-similar to those powers available to authorities under the BRRD for banks, would focus on how best to ensure that, should a CCP encounter financial distress or breach its regulatory requirements, but not yet reach the point of failure, authorities could arrest the situation and restore the viability of the CCP or take other steps to protect financial stability.

Policy option Description 1. No policy change The baseline scenario applies 2. Provide supervisors with means for enhanced monitoring and effective early intervention (including giving directions to CCP in the recovery phase) to attempt to prevent an irreversible solvency situation or other cause of failure from arising. In the case of an unexpected decrease of the financial resources of a CCP, indications of shortcomings in its risk management or indications of a potential emerging crisis situation, supervisors would have enhanced powers, for example, to: obtain greater understanding of the problems at stake at an early stage, enabling the timely adoption of adequate measures aimed at reversing the decline in the financial or operational health of the CCP. direct changes in management practices or of other activities of the CCP that may be at the origin of problems, including: orequire the activation of recovery measures in accordance with the recovery plan (if not already done so) odirecting, where necessary, the implementation of recovery measures (including the order to abstain from the implementation of certain measures) to avoid or minimise adverse effects on financial stability that could result from the CCP’s implementation of certain measures. oremove and/or replace one or more members of the senior management or management body. orequest changes in collateral arrangements, margin requirements, the size or concentration of positions held. 3. Provide supervisors with powers to require CCPs to replenish their financial resources if they had used their capital to absorb losses during a recovery Supervisors would be empowered to require CCPs, that have not already done so, to replenish their financial resources in a timely manner. Option 2: Should CCPs face financial distress, it would be prudent to equip authorities with common minimum powers, enabling them to fully understand as early as possible the potential threats to financial stability arising from this distress which could manifest in either a member default or other (non-default) scenario and to ensure that appropriate measures are taken to mitigate these threats as far as possible. Such powers would complement and harmonise those already in place through a broad provision under EMIR. As part of a recovery and resolution regime, supervisors might need to intervene when a CCP faces financial distress to mitigate two types of problems. First, while implementation of recovery plans is the responsibility of the CCP (based on the trigger framework of agreed in the recovery plan), the execution of relevant recovery measures may be ineffective (for example, in terms of timeliness) or the plan itself may be inadequately executed. Secondly, the actual recovery measures, such as the CCP-led loss allocation tools, might under the prevailing economic circumstances, run counter to the overall objective of preserving financial stability, as the interests of CCPs might not necessarily be aligned with the wider interests of financial stability. After all, CCPs are private, profit making entities which would not necessarily be concerned about the impact of its actions on wider financial stability. Thus, given the highly systemic nature of CCPs, and the potential magnitude of losses that might be allocated to their stakeholders, the relevant authorities might, for instance, need to give directions on the implementation of recovery measures, where warranted by the specific circumstances of the case, to avoid or minimise adverse effects on the wider financial system. As such, it is important that supervisors are adequately empowered to address these types of problems. To this end, CCPs could be obliged by their supervisor to provide detailed information and data allowing authorities to thoroughly analyse the situation. Additionally, authorities could also be empowered to intervene in the management and operations of CCPs considered at risk, where necessary in the public interest. Authorities could, for instance, ask for changes in a CCP’s collateral arrangements, margin requirements, the size or concentration of positions held, management practices or other activities of the entity which might be at the origin of problem(s) causing distress to the CCP. Other powers could include the removal and replacement of one or more members of the senior management or management body, the requirement to activate measures within the recovery plan and the power to direct the implementation of recovery measures (including abstaining from the implementation of certain measures) to avoid or minimise adverse effects on financial stability. Option 3: Where the CCP's financial resources have been used to absorb losses during an event of stress, and are not replenished in a timely manner, the supervisors could be empowered to require a more rapid replenishment so as to ensure that the CCP continues to operate in a safe and sound manner. Preferred options and analysis of their overall impacts in meeting the objectives The preferred options are options 2 and 3. Authorities should be provided with powers to stem where possible the propagation of financial distress within a CCP, as well as potential future financial instability. Authorities should be given the opportunity to use these early intervention powers on their own or in combination in order to mitigate any situation as it arises, before a CCP reaches a point at which there is no alternative other than to place it into insolvency, or where necessary into resolution. The proposed powers, which are in line with CPMI-IOSCO guidance on recovery arrangements for financial market infrastructure, are already available in some Member States (e.g. the UK and Italy) through the implementation of EMIR article 22. By empowering all relevant Member State authorities with the same minimum powers, it ensures that all Member State authorities are able to have greater oversight on the CCP and mitigate financial stability risks as the CCP faces financial distress. In practice, this would mean providing to competent authorities a common toolbox for early intervention purposes. Such measures would complement those already provided under existing EU and national law. It is generally considered to be preferable to attempt to restore the viability of a distressed CCP which is solvent and, on the whole, prudently managed, rather than to restructure it or wind it down, either through insolvency or resolution. CCPs are rarely substitutable and are usually systemically important in their respective markets. Consequently, granting competent authorities powers, amongst others, to issue directions to CCPs in the recovery phase that are not taking the necessary action despite existing arrangements in the recovery plan would support the objectives identified in section 5. Furthermore enabling supervisory intervention at this stage would also be warranted where the implementation of loss allocation tools set out in the recovery plan might have significant adverse effects on the CCP's clearing members and their clients, as well as the wider financial markets and put overall financial stability at risk. The 2012 Commission consultation did not cover potential early intervention tools at length. Thus stakeholders’ views have been obtained through position papers and meetings with industry as well as in the discussions with Member States referred to in section 2.2. On the whole, CCPs and the clients of clearing members do not object to the ability of an authority to intervene in operational aspects of the CCP before resolution. The European Parliament own-initiative report also signals support. Clearing members on the other hand have signalled more reluctance and would prefer for CCP recovery to play out with minimal intervention, except in cases where systemic risks manifestly increase in the process. Member States have signalled that extensive new early intervention powers would not be required, since in some cases (as mentioned above) such powers are already available under national rules, but agree that harmonised minimum powers, e.g., to direct a CCP to take (or abstain from) certain actions in the recovery phase, i.e. to activate or overrule any outstanding contractual arrangements, have merit. In terms of meeting the objectives, the preferred options would represent ways to improve on the baseline scenario. It is acknowledged that recapitalisation may (option 3), while undoubtedly beneficial, come with a higher overall price tag in terms of efficiency. However, considering that this power is generally already available to supervisors, its harmonisation as part of early intervention powers is not considered as a significant source of additional costs across the board. It should be noted that in contrast to the BRRD, it has not been proposed that authorities are able to appoint a temporary administrator to manage a CCP back to health as this would unlikely be necessary or purposeful for CCPs. The circumstances in which action by an authority in relation to a CCP would be necessary are likely to be highly specific. Replacing the management of the CCP and changing its business strategy may not be expedient given that a CCP's failure is more time critical than a bank's (i.e. a faster burn), whereas targeted actions by authorities in accordance with (or divergent from) the recovery plan would likely suffice. Table 2. Comparison of policy options in section 6.3 against effectiveness and efficiency criteria Magnitude of impact as compared with the baseline scenario (the baseline is indicated as 0): ++ strongly positive; + positive; – – strongly negative; – negative; ≈ marginal/neutral; ? uncertain; n.a. not applicable 6.4Possible options to ensure resolution of CCPs in a timely and robust manner (scope of tools and trigger for using them) If the recovery of a CCP cannot be achieved, options should exist for timely resolution. The potential mechanisms to ensure this is set out in this section and the subsequent possible actions to resolve the CCP are set out in sections 6.5 and 6.6. The options in this section address the questions of how and when authorities should resolve a failing CCP so as to ensure the continuity of the entity’s critical functions and safeguard overall financial stability, while avoiding recourse to public funds by allocating losses to the CCP's owners and creditors. This section also covers whether Member States can introduce resolution tools in addition to those discussed sections 6.5 and 6.6 through national law (i.e. whether the proposed resolution toolkit is maximum or minimum harmonising). Policy option Description 1. No policy change The baseline scenario applies 2. Provide authorities with the ability to place a CCP into resolution based on the determination of whether certain conditions have been met (soft trigger) Resolution action would be possible: (i) when a CCP is failing or likely to fail and (ii) alternative measures would not prevent the failure within a reasonable timeframe and other recovery and early intervention options have failed or would be insufficient to restore the CCP's viability or would otherwise compromise overall financial stability; and (iii) when resolution is in the public interest. 3. Provide authorities with clear triggers as to when to enter into resolution (hard trigger) Resolution action would be automatic when specific quantitative thresholds, e.g. specific capital limits, have been breached. 4. Equip resolution authorities with a set of minimum resolution tools and powers to resolve CCPs Comprehensive, but non-exhaustive, powers would enable authorities to take decisive action to restructure the operations of the failing CCP, separating and securing the functions which are critical for financial stability from those which are not. (Sections 6.5 and 6.6 set out the options for the tools for this option or the one below.) 5. Equip Member States with a comprehensive, exhaustive tool kit and set out the order in which the tools should be used. Elimination of legal uncertainties around the use of resolution tools through adopting a more mandatory and prescriptive approach. Maximum clarity over the application or choice of resolution actions. Investors and clients of these entities would know in advance the fate of their assets in the event of a failure and increase their vigilance regarding the safety of their assets and of the CCP’s operations. Option 2: A soft trigger would mean that authorities having the discretion to initiate resolution notably if (i) the CCP is failing or likely to fail; and (ii) alternative measures would not prevent the failure within a reasonable timeframe and other recovery and early intervention options have failed or would be insufficient to restore the CCP's viability or would otherwise compromise overall financial stability; and (iii) resolution would be in the public interest. To limit threats to financial stability arising from the failure or likely failure of a systemic CCP, it is important that, amongst other things, the CCP’s critical functions can continue without disturbance. A soft triggering mechanism would provide authorities with the power to take quick and decisive action to resolve any systemically important CCP while it is still solvent (but close to insolvency) – rather than winding-down the CCP under normal insolvency proceedings in a disorderly manner, thus preventing disturbance to financial stability. Delaying intervention until the CCP has reached insolvency is likely to limit the choice of effective options for resolution, compromise financial stability and increase the amount of losses that would be incurred by stakeholders. As such the resolution framework should provide for timely entry into resolution to ensure its effectiveness. In line with the approach applicable to banks, a CCP should generally be considered as failing or likely to fail when it is or is likely in the near future to meet one or more of the following conditions: be in breach of the requirements for continuing authorisation, when its assets are or are likely in the near future to be less than its liabilities, when it is or is likely in the near future to be unable to pay its debts as they fall due, or when it requires extraordinary public financial support except in carefully prescribed circumstances. Such conditionality also ensures that authorities do not intervene and seize the operations of the CCP too early.

Any further uncertainty linked to the subjective nature of soft triggers could be mitigated by authorities issuing guidance to market participants about their application in crisis situations. Requiring authorities to examine if there are no other private sector or supervisory interventions that could be undertaken to return the CCP to viability within a reasonable timeframe without otherwise compromising financial stability affirms that resolution is a 'last resort'. Excessive and unjust interference with the fundamental rights of shareholders and creditors is thus avoided. Option 3: Hard triggers for resolution, such as a breach of a specific requirement, e.g. regarding capital, would bring transparency to the resolution framework by making it more clearly known ex-ante to all stakeholders when a possible public intervention might be prompted. This would remove authorities’ discretion and leave less room for disputes about the need for resolution. Affected stakeholders would have less margin to block or hinder the resolution process. On the other hand, hard triggers have a number of disadvantages. For instance, they could provide opportunities for regulatory arbitrage on the part of CCPs if they leave undue room for entities to adjust or arbitrage capital, accounting or other measures around the triggers that will compromise the trigger's validity. CCPs may also fail in a manner that may not meet specific hard conditions, and therefore resolution may not be available as an option to achieve an orderly restructuring or wind down of the institution. Moreover, it is difficult to identify single or compound indicators to detect possible threshold problems or predict future events of financial instability. In the recent crisis, for example, the capital ratios of many banks that failed and needed to be rescued by states (and should therefore very likely have been resolved) were above the regulatory minimum. Furthermore, where a situation of crisis is caused by sudden events, relying on hard triggers could result in undue time lags until authorities would be empowered to take action. Option 4: The introduction of a minimum set of common resolution tools for CCPs in all Member States would significantly increase the chances of authorities to achieve a successful and effective resolution and hence maintain financial stability. By introducing the same harmonised powers and specific resolution procedures for CCPs, authorities could use the available tools tailored for CCPs, allowing for an appropriate balance of priorities to be weighed with regard to affected stakeholders. A minimum toolkit would enable Member States to develop further tools to suit national specificities. However, the application of these additional tools must be in line with the resolution objectives and principles that would be set out as part of this legislative proposal. This flexibility would also ensure that legal barriers for Member States to develop ad hoc tools to react to unforeseen crisis situations, should those tools provided within the final adopted proposal not be sufficient, are reduced. Option 5: A maximum harmonisation of the tools, which would prohibit Member States for legislating for any additional tools, and a clear path outlining which tools would be used and in what order could entail an even clearer system for CCP resolution. However, such an approach might risk the effectiveness of a resolution as it would limit the ability of authorities to respond in a flexible way to the specific circumstances of an evolving crisis situation. Furthermore, it appears unlikely that perfectly matched resolution tools and a hierarchy of their use could be developed to address all conceivable crisis scenarios. Such an approach would require some form of standardisation of crisis scenarios and of tools and procedures to be applied according to the scenario, which does not appear realistic. Hence, it is possible that the envisaged resolution measures would not be appropriate to deal with the concrete problems at stake, in particular when it comes to resolving a potentially complex institution in a way that protects financial stability. In an unforeseen systemic crisis scenario, prescriptive resolution procedures risk therefore not being adequate to enable authorities to maintain the critical functions of a CCP. For example, the critical functions might be too technically complex or large to sell to other CCPs in the prevailing conditions without utilising a further tool. Similarly, pre-agreed loss absorption measures might not be sufficient to restore the CCP to viability so as to maintain market and creditor confidence. The resolution authorities might need to apply further ad hoc loss absorption measures to suit the prevailing circumstances to ensure the effective resolution of the CCP. Preferred options and analysis of their overall impacts in meeting the objectives The preferred options are options 2 and 4. The resolution trigger needs to strike the right balance between being flexible enough to enable authorities to resolve a CCP in a crisis and provide an appropriate degree of predictability for stakeholders. In line with the approach adopted for banks, the preferred option would be to leave the decision to the assessment of authorities (soft trigger). However, it is essential to ensure that authorities will only use resolution tools if a CCP is close to failure and no other measures can restore its viability and ensure overall financial stability, and most importantly that it would be in the public interest to place the institution into resolution, rather than normal winding up or insolvency proceedings. Any limitations on the rights of shareholders and creditors, such as CCP's clearing members and their clients, should be in accordance with Article 52 of the Charter of Fundamental Rights. In particular, interference with property rights should not be disproportionate. Affected parties should not incur greater losses than those which they would have incurred if the CCP had been placed into insolvency proceedings. Importantly, despite the conditions for resolution being met, there ought to be nothing to preclude the resolution authority placing non-critical or non-systemic functions of a CCP in resolution into normal insolvency proceedings, if these were deemed to ensure an orderly wind-up of these functions. This trigger mechanism could be backed by guidance from authorities to market participants about how they would assess the triggering conditions in crisis situations. This should provide stakeholders, who sometimes signal a preference for hard triggers on grounds of greater predictability, with a high degree of certainty as to when an authority may intervene and place a CCP under resolution. A harmonised but not exhaustive or prescriptive resolution toolkit that provides authorities with the necessary discretion to take into account the circumstances of a potential crisis is the preferred option. In any case, conceivable paths of how to potentially resolve an entity in various scenarios would be laid out in non-binding resolution plans. Some Member States, in particular those where clearing members are established but not where the CCPs themselves are established, have sometimes expressed the view that resolution plans should constitute a quasi-“presumptive path” of actions which the authority would take and which would be effectively known in advance. However, they acknowledge that even the best-laid plans may require considerable flexibility at the point of resolution. In sum, the overall objectives (financial stability, minimise losses, stronger Single Market) as well as the more specific objectives (as outlined in the table below) are considered to be better served with some degree of flexibility in the deployment of the available powers rather than their use being tied to specific numerical thresholds or predefined scenarios. The same conclusions were drawn for banks under the BRRD.



Table 3. Comparison of policy options in section 6.4 against effectiveness and efficiency criteria 6.5Possible options to carry out resolution (first set of concrete resolution tools) This section and section 6.6 below set out the powers and tools that resolution authorities could have to resolve a CCP. Legislation setting out these tools would improve legal certainty for all stakeholders as to how they would likely be impacted during the resolution of a CCP. Authorities should have a variety of ways to carry out resolution, depending on the specific circumstances of the crisis in question. The options below set out are the generic resolution tools that could be made available to authorities to resolve any financial entity including banks (if justifiable and tailored as necessary), while section 6.6 sets out the options for CCP loss and position allocation. Alongside the options presented below relating to resolution powers, authorities in cross-border cases will need to cooperate as necessary to achieve the objective of efficient resolution. While the specific mechanisms for this improved cross-border cooperation are not discussed separately as a distinct set of options below, it should be considered implicit in all policy options and notably those which are preferred that the necessary cooperative and cross-border institutional framework would have to be in place to execute the decisions. In the case of CCPs, whose business is by nature to a large extent cross border oriented, prudential regulation provides for a broad involvement of relevant authorities in authorising CCPs and in other supervisory tasks via colleges. The question of which authorities should be responsible for CCP resolution would need to be consistent with this framework. Keeping powers at national level to a maximum extent could make decision-making easier and faster and aligned with fiscal responsibilities. However, without the involvement of authorities in other affected Member States, assessing the impact of resolution measures, e.g. on clearing members and their clients based there, could be more difficult and there could be a risk of bias serving national interests. Enhanced cross-border cooperation between authorities, building on existing arrangements including colleges, while potentially more complex and slower, would allow decisions to be based on a more complete overview of the impacts of resolution measures in the affected Member States.

Policy option Description 1. No policy change The baseline scenario applies 2. Write down equity in the CCP or convert to equity any unsecured debt of the entity in a manner that respects the hierarchy of claims in insolvency This would ensure that owners bear a proportionate amount of the incurred losses associated with the failure of the CCP, including, for example, where this goes beyond their contribution to the default waterfall in a CCP and pursuant to other contractual arrangements. To the extent unsecured debt exists, this would also allow to write down or convert (bail-in) the CCP’s unsecured creditors, such as bondholders. 3. Require CCPs to dispose of additional prefunded resources for loss-absorption and recapitalisation, either in a harmonised way or on a case-by-case basis where required by the authorities to address deficiencies relating to resolvability highlighted during the development of resolution plans. To address situations where losses would erode all the capital and other prefunded loss absorbing resources of CCPs, they could be required to dispose of additional paid-up liabilities issued to external investors or raised from clearing participants, which could be used to replenish loss-absorbing resources and recapitalise the entity upon resolution. 4. Transfer of critical functions to a solvent third party or a bridge CCP. The authority could have the power to force a sale of all or some of the CCP's business lines / portfolio on commercial terms to a solvent third party purchaser (which could be a competing company) or to a bridge CCP wholly owned or controlled by the authority to house critical functions before their onward sale to a third party. This transfer would include the transfer of all associated rights and obligations and service-level agreements. 5. Temporary administration A public authority would take over the management of the entity with the objective of correcting any deficient practices and ensuring the provision of critical functions until those functions can be either restored to viability, transferred, replaced by another provider or wound up in an orderly manner. 6. Moratorium on payments and temporary stay on early termination rights (set-off, close-out netting) The application of this power would prevent