The Bank of England (BoE) has published a speech by David Bailey (Director, Financial Markets Infrastructure) entitled The Bank of England’s perspective on CCP risk management, recovery and resolution arrangements.
In his speech, Mr Bailey outlines his views on the progress made to date, internationally and within the UK, to develop and strengthen:
- risk management standards at central counterparties (CCPs);
- CCP recovery arrangements; and
- resolution tools for CCPs.
In relation to CCP risk standards Mr Bailey notes that internationally, the 2012 CPMI-IOSCO Principles for Financial Market Infrastructure (PFMIs), as implemented in the EU by EMIR, have represented a significant step forward. Within the UK, the PFMIs form a key foundation stone of the BoE’s supervisory approach. As part of this approach, the BoE requires CCPs to complete annual self-assessments against the PFMIs. In addition, recognising the importance of UK-based CCPs across multiple jurisdictions, the BoE has placed the PFMI ‘responsibilities’ on international co-operation at the heart of its supervisory approach. However, Mr Bailey states that whilst the PFMIs have taken regulation a long way, they do not represent an end point to the regulatory journey. Instead, he states that they must be viewed as a “very useful baseline” that must continue to evolve and develop to continue to provide for effective CCP risk management. Mr Bailey mentions that, for example, one clear area of the current international standards that could be further developed to strengthen CCPs’ counterparty credit risk management relates to stress testing requirements. Whilst the PFMIs and EMIR require an appropriately and prudently sized default fund, there is no requirement for CCPs to disclose the details of the stress tests which they may use, which ultimately determines the size of these default funds. Mr Bailey also mentions that the BoE would welcome the development of standardised approaches to designing stress scenarios, which could include standardised regulatory stress tests for CCPs.
In relation to CCP recovery arrangements Mr Bailey notes that supervisors need to carefully consider what actions a CCP could take to maintain its economic viability whilst also continuing to provide its critical clearing services. The BoE welcomes the CPMI-IOSCO report on recovery of financial market infrastructures which provides guidance to CCPs on how to answer this question and develop their own recovery arrangements. Mr Bailey states that within the UK CCPs are already required to prepare recovery plans and introduce arrangements to allocate extreme losses. However, he adds that these arrangements will continue to be developed and fine-tuned in response to the periodic tests that the CCPs will undertake and arrangements may need to be updated as clearing services, CCP participants and central clearing mandates evolve. One other point Mr Bailey emphasises is that there is the potential for CCPs to suffer losses, or even fail, for reasons other than member default. Therefore CCPs, together with their clearing members and regulators, must consider the recovery tools that they would employ if a non-default loss depletes the CCP’s capital.
The final issue that Mr Bailey covers is CCP resolution tools stating that a CCP’s risk management should be prudent and robust, and its recovery plans should be designed to be fully comprehensive and effective. However, he adds that it is incumbent on authorities to consider what happens if they are not. Mr Bailey states that the BoE welcomes the recently published annex on resolution set out in the Financial Stability Board’s Key Attributes of Effective Resolution Regimes. The BoE intends to further develop its domestic resolution regime to bring it into line with these international standards. The BoE expects to achieve this via the forthcoming European legislative proposal on CCP resolution which is expected to be proposed next year.