As the clearing landscape evolved after the crisis, some derivatives markets became highly concentrated. Major markets are now cleared through a few global CCPs, which, as a result, have become systemically important for multiple jurisdictions besides the one in which they are headquartered. If not managed appropriately, risks channelled through these CCPs could spread rapidly across borders with potentially destabilising effects for financial markets more widely.
As I see it, fragmentation is not always caused by overlapping regulations, but often by a failure to cooperate. Mutually acceptable solutions can and should be found to meet the legitimate expectations of all the authorities involved.
The scope of these solutions may differ depending on the degree of interconnectedness.
At the European level, for example, where financial markets are highly interdependent and integrated, it is clear that the cross-border stability implications are significant and in many ways exceed those of our banking sector. Supervisory coordination at the EU level should reflect this close nexus.
Unfortunately, however, the competence for CCP supervision remains almost exclusively national. In this respect, despite significant legislative efforts, the lack of ambition of the current revision of the European Market Infrastructure Regulation (EMIR) is regrettable.
At the global level, we should strive for an international framework based on two pillars: proportionality and cooperation.
Proportionality means that where financial stability implications are limited, outcomes-based equivalence and full deference mechanisms, based on compliance with international principles, can allow for cross-border activities that meet minimum standards of safety and soundness.
Cooperation has, in fact, always been the ECB’s preferred approach to the oversight of financial market infrastructures (FMIs). This cooperation should rely on two elements, as agreed at the international level: first, effective cooperative oversight arrangements and, second, crisis management groups to allow for mutual consultation in recovery and resolution planning.
Cooperation is also indispensable for the second topic of today’s conference, namely CCP liquidity and the role of the central bank of issue. In Europe, cooperation ensures that the ECB and the Eurosystem can conduct effective oversight of euro-denominated clearing activities, wherever they may be established.
Let me clarify this by highlighting three channels through which central clearing interacts with core central bank objectives.
First, CCPs play a key role in the euro money market, which is essential for monetary policy transmission. In the EU, 70% of repos are cleared through a CCP, making repo CCPs critically important to this market. CCPs also act as major repo counterparties when reinvesting the large amounts of collateral they collect. Disruptions affecting, or caused by, a CCP can have ripple effects through the euro repo market, which may affect the conduct of monetary policy. The ECB therefore has a clear and legitimate interest in preventing or mitigating such disruptions.
Second, CCPs are financial market hubs connecting banks as well as other market infrastructures, including payment systems. As a result, large payment flows are settled on a daily basis between CCPs and their participants. Deficiencies in CCP financial risk management can transfer liquidity strains to banks, thereby affecting both their capacity to extend credit to firms and households and their reliance on the provision of central bank liquidity, not least as banks are key participants in large-value payment systems operated by central banks.
Finally, central banks can act as a liquidity backstop or a lender of last resort. Such action could be needed if a banking default were coupled with severe market stress. In such a scenario, a CCP would certainly hold high-quality collateral, but it may be unable to generate cash in the market in the very short time it has to manage a default.
Before concluding, let me say a quick word on today’s third topic, the complex challenges CCPs face in managing defaults. CPMI-IOSCO is currently working on default management auctions, which is very welcome as this area of CCP risk management could benefit from further convergence towards shared best practices. The recent default at Nasdaq Clearing has certainly focused the minds of policymakers on this issue. There is much ground to cover for CCPs to converge towards best practices, from setting the right incentives for auction participants to properly calibrating their financial resources to cover concentrated positions in thin or illiquid markets. I am sure this workstream will yield valuable conclusions for both regulators and the industry.
In sum, today’s conference shows that we are continuing to ensure that CCPs steadily become more resilient and sophisticated in their role as systemic risk managers and so can truly manage any situation. At times, this requires imagination to understand the interaction of participant behaviours, complex portfolios and stress scenarios, which is a prerequisite for setting the right incentives. It also requires humility to understand the limitations of this exercise and the need for fall-back plans. Extreme and unexpected events do happen and the very purpose of CCPs is to act as a circuit-breaker during crises.
For CCPs to perform this role as adequately as possible, all relevant authorities, including central banks, need to pull on the same rope. Europe, with its deep financial interconnectedness and high risk of spillovers, requires a particularly close level of information-sharing and cooperative oversight – the prerequisite for the Eurosystem to provide liquidity to CCPs. The role of the central bank of issue thus needs to be acknowledged appropriately.
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