Bank of England Reports on CCPs

Terry Flanagan

The Bank of England expects the amount collateral held by UK central counterparties to increase when mandatory clearing for over-the-counter derivatives is implemented across the European Union through new regulation.

The UK central bank issued its first annual report on securities settlement systems and CCPs since assuming responsibility for their supervision last April. The Bank has held responsibility for the oversight of recognized payment systems since 2009.

The report said the level of counterparty credit risk managed by UK CCPS, and consequently the amount of margin and other collateral they hold, is expected to increase when mandatory clearing for OTC derivatives is implemented across the European Union through the European Markets and Infrastructure Regulation. The Bank said: “It is not yet certain when the first clearing obligations will be implemented.”

The regulator said it has devoted a significant part of its supervisory effort to examining CCPs’ margin and default fund calculations which determine the amount of collateral held. If a CCP does not hold enough collateral it will not have enough protection against the failure of a clearing member failure. The report said: “The two largest UK CCPs have made a number of significant enhancements to their margin methodologies since 2013.”

LCH.Clearnet, ICE Clear Europe and CME Clearing Europe have also worked on their monitoring of liquidity risk in addition to their credit risk management models according to the report. It said: “In response to a Bank expectation that it reduce credit exposure to its concentration bank, ICE Clear Europe moved to using the Bank of England for the provision of intraday sterling liquidity in June 2013.”

UK CCPs also all have loss-allocation rules to manage a loss arising from clearing member default that exceeds their pre-funded default resources to prevent insolvency and ensure that CCPs considered ‘too important to fail’ do not assume support from taxpayers.

The report said: “UK CCPs have also started maintaining recovery plans and developing loss-allocation arrangements for non-default losses. The loss-allocation arrangements must be completed by May 2014 to meet UK rules.”

Last week Mark Wetjen, acting head of the US Commodity Futures Trading Commission, said regulators need to establish a mutual recognition framework for foreign swap execution facilities and foreign derivatives clearing organizations. The US regulator may consider a rulemaking next month that will set forth certain standards for, and a process to permit, some types of clearing arrangements through foreign clearinghouses.

In addition to supervising CCPs the Bank of England is a member of ESMA’s CSDR Task Force developing common European Union laws for central securities depositories.

Draft standards are expected to be consulted upon in September this year and must be finalised and submitted to the European Commission by early next year.

The CSDR will also require the UK to move from a T+3 to a T+2 settlement cycle for securities transactions executed on a trading venue by 1 January 2015. The task force has chosen to move to T+2 on 6 October 2014.

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