With the global RRP framework for banks still in its infancy, there are already efforts to extend the rules to other institutions potentially ‘too big to fail’ such as FMIs. Paul Tucker’s call to include CCPs in the EU’s RRD shows that the BoE is positioning the UK as a leader in this area. UK legislation may well precede the European and international FMI RRP regimes, raising the prospect of imminent operational adjustments for UK CCPs.
Banks are not the only institutions potentially ‘too big to fail’. FMIs are crucial to functioning credit markets, and often provide non-substitutable services. Governments could feel obliged to support them during a crisis, to protect the critical services they provide to the economy. The collapse of the Hong Kong Futures Exchange in 1987 resulted in the closure of the stock market for 4 days; in today’s globalised credit markets the fallout could be wider and even more damaging.
For this reason there has been talk of the need for RRP legislation – designed to mitigate these moral hazard problems – to cover FMIs: it was included in the CPSS-IOSCO Principles on regulating FMIs, and the BIS published a paper on the idea last summer.
Impetus has been added to these initiatives due to the G20 commitment that all OTCDs should be centrally cleared. This would involve a massively expanded role for CCPs across the giant derivatives market. With this development – itself an attempt to manage systemic risk – systemic risk is being concentrated around CCPs as never before. Furthermore, interoperability agreements between CCPs are becoming increasingly common, creating new inter-linkages of exposures.
Tucker argues that “having concentrated risk on the clearing house, it must be redistributed back to market participant in ways that are clear and which incentivise market discipline”. This is the rationale behind his call to redraft the RRD to include CCPs.
EU legislation moves slowly, and the RRD is a complicated document. Therefore, while the Bank of England claims it wants to use the RRD as the central vehicle for implementing RRPs for CCPs, the tone of the recent paper may be a signal of intent by the Bank to develop a UK framework before the directive is finalised.
This raises the prospect of UK CCPs having to adapt to the substantial operational requirements of RRPs before their continental counterparts. Furthermore, work will have to be done to ensure that the UK legislation and the eventual EU response are co-ordinated if fragmentation and arbitrage problems are to be avoided.
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- Will the BoE front-run legislation ahead of the RRD even if CCPs are included in the directive?
- To what extent will the European response be coordinated with UK initiatives in this field?
- Will others follow a UK blueprint or will we see a fragmentation of the international FMI RRP landscape?