The European Commission (the Commission) has published a proposal for a Regulation on the framework for the recovery and resolution of central counterparties (the draft Regulation).
The draft Regulation is intended to ensure that central counterparties (CCPs) are better prepared to recover from financial distress and provide appropriate authorities with new powers to recover or resolve CCPs, which are failing or likely to fail, so as to preserve their critical functions while winding up other operations.
The provisions within the draft Regulation are comparable to those in the Bank Recovery and Resolution Directive (BRRD) which sets out a recovery and resolution framework applicable to banks and investment firms. However, the draft Regulation adapts the BRRD’s provisions to the specific features of CCPs’ business models and the risks they incur, including by determining how losses would be shared in scenarios where existing CCPs’ pre-funded resources required under the European Market Infrastructure Regulation (EMIR) are exhausted.
Key elements of the draft Regulation are:
- the framework is based first on prevention and preparation. The proposed rules require CCPs to draw up recovery plans which would include measures to overcome any form of financial distress which would exceed their default management resources and other requirements under EMIR. This will include scenarios involving defaults by clearing members of the CCP as well as the materialisation of other risks and losses to the CCP itself, such as fraud or cyberattack. Recovery plans will be reviewed by the CCP’s supervisor. Member state authorities responsible for resolving CCPs (i.e. resolution authorities) are required to prepare resolution plans for how CCPs would be restructured and their critical functions maintained in the unlikely event of their failure;
- member state supervisors are given specific powers to intervene in the operations of CCPs where their viability is at risk but before they reach the point of failure or whether their actions may be detrimental to overall financial stability. Supervisors could also require the CCP to undertake specific actions in its recovery plan or to make changes to its business strategy or legal or operational structure; and
- member state resolution authorities are given resolution tools which are designed to ensure that essential clearing functions and services are preserved without the need to bail out the CCP.
The main resolution tools are the:
- sale of business tool whereby the member state resolution authority would sell all or part of the failing CCP to another entity;
- bridge CCP tool which consists of identifying essential functions of the CCP and separating them into a new CCP (bridge CCP) which could be eventually sold to another entity. The old CCP with the non-essential functions would then be liquidated under normal insolvency proceedings;
- position allocation tool (i.e. partial or full termination of contracts) which aims at re-matching the book of the CCP;
- loss allocation tool (i.e. haircutting of variation margin and cash calls enacted by the member state resolution authority) which aims to cover the losses of the CCP, restore its ability to meet its payment obligation, recapitalise the CCP and replenish its pre-funded financial resources; and
- write-down and conversion of capital and debt instruments or other unsecured liabilities tool which aims at absorbing losses, recapitalising the CCP or bridge CCP or support the use of the sale of business tool.
The draft Regulation does not mandate which tools and powers to use in different scenarios. It instead leaves the choice of the most appropriate tool in each situation to the member state resolution authority. However, where practicable, the member state resolution authority should act in line with the agreed resolution plan.
In summary, a CCP will become subject to resolution when:
- there are no realistic prospects of recovery over an appropriate timeframe;
- all other intervention measures (such as the default management procedures foreseen in a CCP operating rules or its recovery measures) have been exhausted or could impede the financial stability of one or more member states; and
- winding up the CCP under normal insolvency proceedings would risk prolonged market uncertainty and financial instability.
Entry into resolution will occur at a point close to insolvency although member state resolution authorities have a degree of discretion to ensure that they can intervene before it is too late for resolution to meet its objectives.
The European Securities and Markets Authority (ESMA) is to issue guidelines to promote the convergence of supervisory and resolution practices regarding the application of the circumstances under which a CCP is deemed to be failing or likely to fail. When issuing these guidelines ESMA shall take into account the guidelines issued in accordance with Article 32(6) of the BRRD.
The proposal requires an appropriate coordination of resolution measures in a cross-border context to protect financial stability in all affected member states and achieve the most effective outcome for the resolution of a CCP. Given the role set by EMIR for colleges of member state supervisory authorities, as well as the possible impact that resolution action can have on clearing members and other stakeholders, CCPs’ member state resolution authorities will be required to set up and chair resolution colleges for each CCP. The resolution college will include all relevant resolution authorities from across the EU.
ESMA is to play a coordination role both during the prevention and early intervention stages with a view to facilitating the adoption of joint decisions (acting as a binding mediator if necessary). To prepare its decisions, ESMA will be required to set up a resolution committee composed of CCPs’ member state resolution authorities. In addition, to ensure the full input of the supervisory and resolution authorities of banks (i.e. the CCPs’ clearing members), these authorities shall be invited to participate as observers to the ESMA resolution committee.
CCPs will be required to ensure that the relevant measures set out in their recovery plans are legally binding across jurisdictions. This means ensuring that recovery options constitute contractual obligations under the law of the country in which the CCP is established, or otherwise demonstrating to the satisfaction of the relevant member state supervisory authority and member state resolution authority that the recovery plan is enforceable, for instance under the law of a relevant third country.
The proposal enables member state resolution authorities to require CCPs to amend their contracts and other arrangements, in particular under their operating rules, so as to facilitate the effective achievement of resolution actions that would affect assets, contracts, rights, liabilities and instruments of ownership of persons located in or governed by the law of third countries.
To facilitate the enforcement of actions by third country resolution authorities on relevant clearing members, contracts or other assets or liabilities located in the EU, relevant member state resolution authorities will be in charge of recognising and giving effect to them, or refusing to do so in specific circumstances. Recognition will occur provided the third country resolution measures do not have an adverse effect on the financial stability of the member state, creditors of the CCP receive the same treatment as other creditors regardless of location, and there would be no material fiscal implications for the member state.
Once adopted the draft Regulation will take effect once the Commission’s proposal amending the BRRD (put forward on 23 November) takes effect. This proposed amendment to the BRRD extends the scope of application on penalties to CCPs. Such extension ensures that sanctioning powers regarding recovery and resolution of financial institutions are consistent.
The draft Regulation will be submitted to the European Parliament and the Council of the EU for their approval and adoption.
View Proposal for a Regulation on the framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No. 648/2012 and (EU) 2015/2365, 28 November 2016
View Annex to the Proposal for a Regulation on the framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No. 648/2012 and (EU) 2015/2365, 28 November 2016
View Commission Staff Working Document Executive Summary of the Impact Assessment accompanying the proposal for a Regulation on the framework for the recovery and resolution of central counterparties and amending Regulations (EU) No 1095/2010, (EU) No. 648/2012 and (EU) 2015/2365, 28 November 2016
View Fact sheet: Central Counterparties Recovery and Resolution Proposal: FAQs, 28 November 2016
View Fact sheet: Safer financial infrastructure, 28 November 2016