The European Systemic Risk Board (ESRB) has published a report to the European Commission on the systemic risk implications of central counterparty (CCP) interoperability arrangements. The report constitutes the ESRB’s assessment of interoperability arrangements as required by article 85(4) of the European Market Infrastructure Regulation (EMIR).
The ESRB believes that CCP interoperability arrangements can have implications for financial stability in two ways:
- such arrangements can help to contain systemic risks in a situation where a number of different CCPs clear the same financial instruments, insofar as they allow intermediaries to hold their position with one CCP, instead of “fragmenting” it across different CCPs. This increases netting possibilities, helps to limit demand for eligible collateral, and avoids situations where the default of a clearing member triggers parallel default procedures; and
- CCP interoperability arrangements can have systemic risk implications, since the establishment of interoperable links introduces a significant element of complexity into the overall risk management system and adds a channel for direct contagion between two or more CCPs. Inter-CCP exposures therefore must be: (i) properly monitored (including through an appropriate exchange of information between interoperable CCPs and relevant national competent authorities (NCAs); (ii) addressed by means of a sound risk management framework; and (iii) backed by adequate financial resources.
The ESRB also notes that the most significant implications of interoperability arrangements in terms of systemic risk materialise in the event of an interoperable CCP defaulting. The report therefore points to the need to carefully develop recovery and resolution procedures for CCPs in order to contain the potential contagion that could stem from the default of an interoperable CCP.
The ESRB also sets out in the report certain policy issues that it feels merit further attention. These include:
- when it comes to recovery and resolution procedures for CCPs, the role of interoperability arrangements in a CCP default waterfall could be clarified to specify the contingent commitments of linked CCPs in the event that pre-funded financial resources are depleted; and
- as far as derivatives are concerned further analysis should be undertaken on the specificities and complexities relating to potential new derivatives links, in particular the complexities relating to potential over-the-counter derivatives links.