The WFE is calling for a careful and considered approach in any change to resolution arrangements at CCPs, as upsetting the tried and tested balance of incentives could damage stability and increase systemic risk.
A core element of central clearing’s value is the predictability of the arrangements to address pre-specified contingencies, together with an incentive structure reinforced by these arrangements’ predictability, the WFE said, in response to the Financial Stability Board’s consultation on the treatment of CCP equity in resolution.
The other key issue in resolution planning concerns realism. While the WFE welcomes the FSB’s leadership on this issue, a significant constraint in considering the approach to resolution planning lies in finding a likely extreme scenario that is also plausible. Unfortunately, the FSB’s draft guidance appears to propose a set of scenarios for adjusting the treatment of CCP equity that is both extreme and implausible.
Nandini Sukumar, Chief Executive Officer, the WFE said: “The current treatment of CCP equity has been carefully determined, consistent with international standards, to promote incentives for market participants to back the risks they bring to the CCP, and thereby support the stability of the broader financial system. An essential part of this consists of incentivising market participants’ effective participation in the default management and recovery processes. Creating potential rewards in resolution (eg, exposing all CCP equity as a first-loss resource) could undermine the CCP’s resilience or its ability to recover.’’
Coming soon: Lynn Strongin Dodds interviews Nandini Sukumar.