Market leading clearing, risk and regulatory experts Catalyst Development Ltd have welcomed CPMI-IOSCO’s publication of guidance on the recovery of Financial Market Infrastructures (FMIs), calling the guidance “a clear move to prevent disorderly failure and avoid severe systemic disruptions through a comprehensive and effective recovery plan”.

However Catalyst are also warning that, to ensure market stability, CCPs and regulators must implement the guidance fully and swiftly – and should also recognise that many users would welcome stronger action.

Published earlier this month (October 2014), the new guidance sets out a comprehensive toolkit for CCP recovery, spanning not just the counterparty risk inherent in a Clearing Member default, but also liquidity, investment and operational risks.

Lifan Zhang

Christian Lee, Head of Catalyst’s Clearing, Risk and Regulatory team commented “the scale of change this guidance covers should not be under-estimated. The challenge is for regulators and CCPs alike to adopt the guidance fully and strengthen the resilience of financial markets as a whole.”

Before the onset of the financial crisis, CCPs played an important but often hidden role in the functioning of the financial system, providing a structure that guaranteed the performance of key markets – principally cash equities and exchange traded derivatives. Now CCPs have been thrust into the limelight and have a much bigger role in the protection of key OTC markets.

Damon Batten, OTC derivative reform and regulatory expert at Catalyst, suggests that “this has greatly increased the scale and complexity of risks they manage, transforming many CCPs into a new class of systemically important institution. Even so, CCPs are no panacea. A handful of CCP failures have occurred over the past 40 years. Within the last five years there have been a small number of incidences of a CCP needing to use its Default Fund, including one recent incident arising from a trading error, which received widespread coverage in the financial press. Arguably, the assumption of the complex risks associated with OTC markets will increase the risk of CCP failures, which in turn means that CCPs must increase their own risk frameworks.”

Catalyst believe the new guidance will be welcomed by users of CCPs. However they also recognise that those who have been pushing for higher standards for some time may feel it does not go far enough, as it still falls short of the measures advocated by a number of institutions. These include JP Morgan, who recently proposed that CCPs adopt a controversial recapitalisation fund; a call that met with resistance from the major CCPs.

Lifan Zhang, market risk expert at Catalyst comments “the challenge now rests firmly with regulators and the CCPs they supervise. The measures in this new guidance will raise standards for CCPs globally and pose complex legal and operational challenges in some jurisdictions. If CCPs actively align themselves with the guidance and consider the broad reach of any recovery plan over various risk categories and failure scenarios, they should be able to manage users’ concerns, demonstrate their commitment to maintaining best in class infrastructure and as a result, enhance the stability and resilience of global financial markets.”