In a joint review of 10 derivatives clearing houses across nine jurisdictions, the Bank for International Settlements and the International Organization of Securities Commissions found that a number had not yet put in place a full set of recovery rules and procedures to deal with significant losses – including those arising from member defaults.
A set of joint principles on the resilience and recovery process for clearing houses was issued by the two organisations in 2012.
In a report published on August 16, the authorities found that while many clearers had made “important and meaningful” progress in implementing the principles, it also added there were “gaps and shortcomings”.
In particular, it found clearers did not test enough “liquidity-specific scenarios” in their stress tests.
Clearers stand in the middle of a trade to assume the counterparty risk, and have taken on an enhanced role since the crisis to reduce risk in derivatives markets. However, critics fear they have become the new too-big-to-fail institutions, prompting scrutiny of their ability to deal with significant losses.
In the event of a member default, clearing houses first attempt to manage losses using existing resources, such as collateral contributions from their members, as well as its own resources. Thereafter, recovery and resolution schemes kick in to provide uncovered losses, which may include calling on members for additional capital.
Iosco and BIS wanted to a lay out a framework for recovery processes through their 2012 standards, but its review found some “serious issues of concern” in the areas of credit and liquidity risk management.
The joint review found that all but one of the clearers studied had a “target” amount of pre-funded resources designed to cover the default of a single member that would cause the largest credit exposure. The review also found that clearers with a more complex risk profile – such as those clearing credit default swaps – may have resources to cover the default of two members.
However, the review found that not all clearers had necessary policies and procedures in place sustain this funding. In particular, they did not have clear processes in place to address any breach of this target level of funding promptly.
Clearing houses that fall short in those two areas must address the issues by the end of 2016, the report said. Similarly, clearers with shortcomings in their recovery plans are expected to “accord the highest priority to developing and completing their plans” by the year end.
The European Commission is set to produce a draft proposal on recovery and resolution for clearing houses this year that builds on the BIS/Iosco guidelines.
The clearers involved in the assessment were: Australia’s ASX Clear (Futures), Brazil’s BM&FBovespa, Clearing Corporation of India, CME, Eurex Clearing, Ice Clear Credit, Japan Securities Clearing Corporation, LCH.Clearnet SA, LCH.Clearnet Ltd (SwapClear), and Singapore’s SGX Derivatives Clearing.
A follow-up review is planned for the first half of 2017, the BIS/IOSCO report said, and is expected to cover a wider range of clearer and product classes.