ISDA, FIA and the Institute of International Finance (collectively, the "Associations") provided an "incentives analysis" concerning central counterparty ("CCP") resolution issues raised by the Financial Stability Board ("FSB") in a discussion paper. The FSB discussion paper lays out considerations for authorities with regard to whether existing financial resources and tools are sufficient to implement the resolution strategy for CCPs.

The analysis outlines incentives for CCPs, clearing members and their clients with respect to various tools and processes relating to CCP recovery and resolution. The Associations found, among other things, that:

  • there was "strong support" from their memberships (on both the buy- and sell-side) for the view that initial margin haircutting and forced allocation raise "significant" market stability concerns;
  • members had differing views as to "variation margin gains haircutting," with some firms believing that it should be used only on a limited basis by resolution authorities, and others believing that a CCP should have more flexibility to use the tool in recovery;
  • incentives among stakeholders are not well aligned under a "resolution cash call," and many firms did not see the tool as suitable for CCP recapitalization;
  • firms had differing views as to the "skin-in-the-game" tranche of CCP funds in a waterfall, but the Associations expressed a general belief concerning incentives to align interests from skin in the game; and
  • firms had strong support for compensating clearing members who bear losses beyond their default fund contributions and (capped) assessments.

In addition, the Associations requested that the FSB articulate the appropriateness of a "no-creditor-worse-off-than-in-liquidation" safeguard for equity holders. The Associations said that "it is not at all clear why equity holders should be entitled to anything more than the residual value of a remnant CCP, after payment of creditor claims."

Commentary / NihalPatel

This document is a useful analysis for persons considering the tricky-but-necessary policy debate of what to do about a failing CCP. While clearly an advocacy piece, the document does a reasonable job of considering various FSB proposals and the potential costs associated with them, while conceding that: (i) there is no single approach that does not have downsides for some or all of the relevant stakeholders and (ii) many CCPs will disagree with the views expressed in this document.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.