To address this concern, in 2012, international standard setters issued a set of minimum risk management standards for financial market infrastructures including CCPs.4 These principles, known as the “Principles for Financial Market Infrastructures” (PFMIs), require that a CCP maintain sufficient liquid resources. This includes the requirement that a CCP have a pre-funded default arrangement and that the CCP collects initial and variation margin. In particular, the PFMIs stipulate that a CCP must be able to withstand, in a stress environment, the failure of the member having the largest exposure to the CCP. In some cases, this requirement is strengthened to require the ability to cover the failure of the two largest members. The PFMIs also require the CCPs to develop effective methodologies to estimate their funding exposures, so that they can better manage their liquidity risks. Another important risk management task for CCPs is the on-boarding of new members and the monitoring of the condition of existing members. The strength of the CCP is ultimately derived from the collective strength of its members. The mutualization of the CCP’s net credit risk across its members creates an incentive for its members to only want well-capitalized and well-managed members as part of the CCP. The CCP also must ensure that members are meeting their margin requirements and remain in good standing. It is also worth noting that these safeguards for CCPs will need to be put into place along with other reforms such as the use of multilateral trading platforms and trade repositories.

Structuring a long-term debt requirement so that a meaningful component consists of deferred compensation held by senior management would presumably strengthen the incentives for proactive risk management. In my opinion, more research is needed into how the structure of management compensation for financial firms could incentivize good risk management and limit the appetite for excessive risk.1 Even if every jurisdiction were to successfully implement these types of initiatives and consequently reduce the default risks associated with their G-SIFIs, the risk of failure would not be fully eliminated. This means there would always be some residual risk of major disruptions to financial markets due to a disorderly default of a large financial firm. Consequently, the development and implementation of credible resolution mechanisms for G-SIFIs is the second key component of a global strategy to improve financial stability. By credible, I mean that if the situation of an impending G-SIFI default arises, the home authorities will proceed with the resolution plan, rather than give in to pressure to intervene to prevent the failure. This requires that the resolution mechanisms be capable of significantly mitigating the negative externalities associated with winding down a failing G-SIFI. Although the specifics of the resolution mechanisms will necessarily vary to some extent across jurisdictions, reflecting differences in institutional structures, legal frameworks, and regulatory regimes, the goal is common – to be able to resolve any G-SIFI regardless of its home  1  Structuring this in a way to get the incentives right is critical.