Losses from the tear-up of positions would still be expected to be allocated in the order contractually agreed in the rulebook without discrimination between counterparties. But the discretions exercised by the resolution authority, such as the scope and price of the partial tear-up or the speed of replenishment of the depleted default fund would be taken with objectives to protect financial stability and subject to public law safeguards. In taking these actions the resolution authority would have the advantage of being able to coordinate and exchange information with other domestic and foreign authorities and with the wider market in a way that the CCP would not. This ability to coordinate could be crucial to the orderly management of a systemic event particularly if defaults were impacting multiple CCPs. An important aspect of stabilising the CCP and the wider market would be to maintain sufficient certainty around the losses that could be incurred in the resolution. A CCP’s rulebook provides its members with assurance ex ante about the point at which and the extent to which they will be exposed in the event of a clearing member default. It protects them from discrimination in the allocation of losses. Resolution authorities should similarly respect the CCP rulebook in the allocations of loss. If, in extreme circumstances, it proves necessary for the resolution authority to deviate from the rulebook, CCP members should be compensated for losses borne in excess of what would have been incurred had the rulebook been followed.

https://www.bankofengland.co.uk/-/media/boe/files/speech/2016/redeeming-an-unforgivingworld.pdf?la=en&hash=7B7AC35CC3017FCD8EF5BE7D5F2D0C4EA22C7E05  6  All speeches are available online at www.bankofengland.co.uk/speeches  6  resolution failed, and defaults occurred, it would take the failure of more than the CCP’s two largest clearing members in extreme but plausible market conditions to lead to the exhaustion of the default fund – this is a scenario, in the tail of the tail, which would almost certainly be more severe than those we have seen historically, including in the crisis. The crisis has, of course taught us, that we need to think about events in the very tail of the probability distribution. So we do need to ask what happens when prefunded loss absorbency is exhausted and insufficient to cover losses. Unlike banks, if prefunded resources are insufficient to absorb losses, the CCP does not become insolvent. CCP’s rulebooks, to which all members agree in advance, allow a further series of recovery actions, in a prescribed sequence. A CCP could require its members to contribute more resources, it could reduce its liabilities to some of its members, and ultimately it could “tear –up” (i.e. cancel) all or some of its contracts – in effect the closure of the clearing service. The sequence of ever more draconian actions, reflect the fact that CCPs are not independent risk takers. In fact, they should not be risk takers at all. They are services that, for a fee, manage the risks of derivative counterparty default that their members would otherwise face directly and at far greater cost. Again, the comparison with banks is instructive.