Since ‘too big to fail’ changed its name to ‘systemically important’, regulators have been eager to show that they are ready and willing to resolve unviable banks. Part of this approach has been to champion the virtues of financial market infrastructures (FMIs) such as clearing houses (CCPs), central securities depositories (CSDs) and payment systems. However, is too much faith now invested to the point that these middlemen have now become the new ‘too big – or too important – to fail’?
This year, the EU is laying the groundwork for a recovery and resolution strategy for non-banks (FMIs and insurance firms). To this end, the European Commission (EC) issued a consultation paper last October asking market participants for their recommendations. Given the various stakeholder industries in this consultation, the 67 responses came from a diverse range of institutions: banks, insurers, asset managers et al.
Most important at present, given the approaching EMIR deadlines, are those sections that apply to FMIs. Central clearing obligations, specifically EMIR (Article 4), require financial counterparties to engage the services of a CCP in the trading of OTC derivatives. The advantage of this is that it reduces the risk to the clearing parties. However, this is achieved by centralising that risk in the CCP. This means that, while the bank can now be successfully resolved without threatening its counterparties, the CCP web is becoming harder and harder to unravel.
It is for this reason that many of the responses to the consultation push the emphasis towards recovery and not resolution. For instance, the prime concern of many respondents was how regulators would ensure the continuance of critical functions. Many also asked for clear steps to be put in place before the recovery stage so that service disruption could be kept to a minimum. Finally, many suggested that ‘triggers’ should be diluted in order to give FMIs greater discretion over when to implement their recovery plans (as with the most recent draft of the EU RRP Directive).
Fundamentally, with the increased responsibility placed on CCPs (and the tendency of the business model towards producing a market monopoly) the feedback from a possible default could be catastrophic. Therefore, to threaten hard-handed resolution methods that scare investors, such as suspending termination rights or imposing losses on stakeholders, could introduce huge risk to the system. However FMIs should be alert to the likelihood that these policies might come into law soon and be preparing for such an eventuality.