The Bank of England has approved measures that will see it provide central bank funds to UK clearing houses and broker-dealers in order to safeguard its financial system in a crisis.
The Bank can now offer emergency liquidity services to UK clearing houses that are approved under the European Market Infrastructure Regulation (EMIR). These emergency services include access to reserve accounts, operational standing facilities, and the discount window facility.
Approved clearing houses include CME Clearing, LCH.Clearnet and LME Clear.
Clearing houses, or central counterparties (CCPs), stand between two parties in a trade, guaranteeing payment if one side of the trade defaults. They are meant to act as the financial market’s shock absorbers.
Post-crisis reforms has brought clearing houses to the forefront and their importance has risen dramatically. However, it has at the same time sparked fears about the impact on the wider financial system if one were to fail.
In a speech last summer, Bank of England governor Mark Carney recognised certain weaknesses in the clearing house default model, warning that markets could “seize up” in crises and threaten the financial stability of the wider economy.
“In the coming year, the Bank will widen access to our facilities to include the largest broker-dealers regulated in the UK and to those central counterparties authorised to operate in UK markets,” Carney said in June.
In a white paper published by J.P. Morgan in September, it too argued the current CCP default model was ill-equipped to handle a financial crisis, and called for a number of substantive changes.
The ruling from the bank will be welcomed by both clearing houses and its members. For clearing members, such as J.P. Morgan, it will put rest to fears that they might have to stump up billions in cash to ensure the CCP lives on during times of crises. For clearing houses, central bank liquidity would mean they would not be required to dramatically increase direct contributions to the guarantee fund.
With the additional funds from central bank liquidity, clearing houses will be able to cover a greater range of potential disasters.
Furthermore the ruling follows the announcement from the International Organizations of Securities Commissions (IOSCO) last month, which said CCPs and central securities depositories (CSDs) should be given all the necessary tools to enable recovery from potential losses from general business, custody and investment risks.
Speaking at the Futures Industry Association expo in Chicago on Wednesday Timothy Massad, chairman of the US Commodity Futures Trading Commission, said they are working with the US central bank on measures to prevent clearing house default risks.
“I believe everyone here understands that, while clearing houses are a good way to monitor and mitigate the risk of transactions that would otherwise be conducted on a bilateral basis, they do not eliminate risk.
“That’s why we are working closely with the Federal Reserve now on major clearing house issues. Regulators must work together to make sure clearing houses operate transparently, meet necessary standards and safeguards, and do not pose risks to financial stability.”