Experts at the Financial Stability Board (FSB) are seeking comment on the range of powers and tools which could be made available to authorities and central counterparty clearing houses (CCPs) in the event of a failure.

CCPs, which mitigate and manage counterparty credit risk, are an increasingly important part of the financial system, particularly following post-crisis reforms.

Certain standardised over-the-counter derivatives are now being forced through CCPs and greater use is also being encouraged across securities financing and repo markets.

However, given their critical role, there are concerns that CCPs are themselves becoming a new source of too-big-to-fail risk.

A discussion note sent out by the FSB this week covers a number of aspects of CCP resolution planning, including timing of entry into resolution; adequacy of financial resources and allocating default and non-default losses.

In theory, the post-crisis measures to end too-big-to-fail should help reduce the likelihood that clearing members default on their obligations to CCPs.

However, CCPs can be exposed to losses arising from causes other than member defaults: for example, losses could arise from custody, settlement and investment risk; financial impacts of operational risks such as cyber-attacks; or potential litigation.

"Authorities should consider what resolution powers are necessary to ensure the continuity of the critical functions of the CCP in resolution, which could include temporary control (including a statutory manager or equivalent), ownership or the creation of a bridge CCP," FSB experts wrote in paper.

At one extreme, the FSB says a fixed order of losses could be set out in advance, for example in statute, regulations, and/or the rules of the CCP, with no legal power whatsoever for the resolution authority to depart even where they consider a “better” option for financial stability may be available.

This would provide the highest level of certainty to participants, but probably also contains the highest latent risk to public funds being exposed.

At the other extreme, there would be explicit provisions asserting that the resolution authority can choose among all available tools it considers necessary for achieving the resolution objectives and also to apply them in any order it considers necessary.

Resolution plans should also be tailored to the specific risks and systemic implications that a particular type of CCP may be exposed to or create, the paper states.

In addition, a combination of approaches might be deemed necessary depending on the scenario or to accommodate the structure and business model of the CCP and the legal regimes under which it operates.

“CCPs form a central part of the post-crisis reforms of OTC derivatives markets to help reduce risk in the financial system,” said Elke König, chair of the FSB Resolution Steering Group and chair of the European Single Resolution Board.

“But we must also ensure that CCPs are themselves robust and this includes appropriate resolution regimes. There has already been much industry comment on CCP resolution, and we welcome further public comment in response to this discussion note to support the work of the FSB as part of the overall CCP workplan.”

The FSB, together with the Basel Committee on Banking Supervision (BCBS), CPMI, and IOSCO, agreed in April 2015 on a joint workplan to coordinate their actions to enhance resilience, recovery and resolvability of CCPs.

A progress report non the workplan was also sent out by the regulators this week. 

A finalised report on more granular guidance for CCP resilience and recovery is set to be published in the first half of 2017.