Central counterparties (CCPs) are a benefit to the marketplace and play a major role in reducing systemic risk.
Eurex, in a white paper first published in July, said that CCPs while reducing systemic risk in financial markets also provide the marketplace with specific recovery and resolution frameworks for financial market infrastructures.
Thomas Book, chief executive at Eurex Clearing, the CCP of Deutsche Borse Group, wrote in “How Central Counterparties Strengthen the Safety and Integrity of Financial Markets,” that the new CCP model shows “the macro-prudential advantage of a centrally cleared market versus a bilateral one.”
Hence, he continued, the regulatory agenda to broaden the use of CCP clearing together with high regulatory requirements makes financial markets more robust and transparent and benefits the wider economy. In particular central clearing reduces risks in bilaterally negotiated products such as OTC derivatives and allows for the mitigation of systemic risks in these markets.
“The White Paper shows the macro-prudential advantage of a centrally cleared market versus a bilateral one,” Book wrote. “CCPs demonstrated their resilience and benefits during the recent crisis. As the new regulatory regime takes shape the positive features of cleared markets will be further strengthened. Of great importance are the recovery and resolution frameworks which ensure that systemic events can be managed appropriately.”
The White Paper first analyses the functioning of a CCP and the effect central clearing has on systemic risk mitigation in financial markets. As independent risk managers between market participants, CCPs ensure prudent collateralization and have procedures to manage defaults in an orderly manner.
The second part of the paper outlines the necessary standards and features that need to be met when operating a CCP. An analysis of past disruptions of CCPs against regulatory requirements shows that EMIR, the European post-trade regulation, already sets highest standards and can serve as a regulatory benchmark globally.
The final part of the paper discusses the ways in which the CCP mechanism permits markets to recover – or be wound down – if unprecedented market shocks overwhelm the existing safeguards without disrupting the entire financial markets. While existing regulation already strengthens the CCP construct, the added safety of specific recovery and resolution frameworks for financial market infrastructures enable the CCP stakeholders to act decisively to resolve such market shocks and exclude public bail-outs. Consequently, CCPs mitigate systemic risk and strengthen the robustness of financial markets.
