CCP link agreements still need work to make them safe

Despite last week’s guidance from UK, Dutch and Swiss financial regulators about their requirements for secure interoperability agreements between central counterparty (CCP) clearing houses, a perfect solution for the links has yet to be found, according to CCPs’ members.
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Despite last week’s guidance from UK, Dutch and Swiss financial regulators about their requirements for secure interoperability agreements between central counterparty (CCP) clearing houses, a perfect solution for the links has yet to be found, according to CCPs’ members.

“I am more than happy to listen to any type of innovative approach as long as it makes sense, is safe and is guaranteed not to create any additional risk. At this stage, none of the proposals on the table have proven to me that this is the case,” Julien Kasparian, head of UK sales and market infrastructure at BNP Paribas Securities Services, told

A group of three financial regulators, comprising the UK’s Financial Services Authority, the Netherlands’ AFM, Switzerland’s FINMA plus the Swiss and Dutch central banks, issued a statement earlier this month asserting that inter-CCP links create additional counterparty risks, which need to be mitigated by additional collateral to that already provided to cover members’ risks.

However, the regulators stopped short of prescribing how such additional collateral would be collected, suggesting only that CCPs might consider augmenting their default funds or charging supplementary margin sums to participants.

While banks accept that interoperability will come at a price, whether through greater contributions to clearers’ default funds or additional margins, it is still unclear what the cost will be.

“The devil is in the detail,” said Satvinder Singh, managing director and direct custody and clearing business head for Citi’s Global Transaction Services business, EMEA. “We don’t know if it is going to be an additional margin or a default fund contribution. Nobody knows what the amount is going to be or how CCPs are going to deal with trading participants that have a zero position at the CCP each day. Therefore it is difficult to say right now whether the cost of interoperability is justified.”?

A high-frequency trader, for example, while generating high volumes of trades, would have no net position at the end of the day.

Both BNP Paribas Securities Services and Citi offer a general clearing member service, under which they offer non-members access to the CCPs they have joined.

One concept that has been largely shunned by clearing members and appears to have been abandoned is sharing member collateral between CCPs to offset interoperability risks.

“As a clearing participant, we would not want to see the kind of set-up where CCPs would try to ensure the safety of a link by transferring capital rather than augmenting their default fund,” said Kasparian. “This potentially means they could rehypothecate our collateral to another CCP, which in turn could be interoperable with any of the other nine CCPs in Europe. You don’t know where your collateral will end up.”

Any lack of clarity about the location of collateral can make it difficult for clearing participants to assess their exposure to a CCP at a given time.

One idea that seems to have gained the most currency among CCP members is greater contributions to default funds. This method was put forward by pan-European clearing house EuroCCP in January as one of a series of recommendations to achieve effective interoperability.

“EuroCCP’s idea has struck a chord with regulators because it solves a number of issues associated with rehypothecation and ringfencing of cross-CCP margin contributions,” said Singh.

However, it is still unclear how CCPs would stump up additional emergency collateral for liabilities they are exposed to through interoperability. Some clearers’ rules, such as those governing Dutch-based CCP European Multilateral Clearing Facility (EMCF), expressly forbid the use of member margins for funding anything other than that member’s liabilities – although EMCF is applying to change this. “What if you are not able to source the liquidity?” asks Kasparian. “If this breaches the rules, does that mean that other CCPs will be in a position to disconnect you? All of those kinds of questions so far have not been answered.”

Clearing members are also keen to ensure that the details of interoperability arrangements entered into by the CCPs it uses are fully disclosed.

For Kasparian, an ideal solution would be a clearing equivalent of the European Central Bank’s TARGET2-Securities pan-European central securities depositary project. “The European Commission, through MiFID and the Code of Conduct more specifically, has suggested interoperability and transparency, but unfortunately due to commercial barriers and interests in Europe, I think that interoperability might have to be mandated,” he said.

Given the various challenges that still need to be addressed, few are expecting a speedy solution to interoperability. In last week’s communication, the regulators announced they would be examining the only currently active interoperability arrangement for equities – between LCH.Clearnet and SIX x-clear for the London Stock Exchange. Kasparian estimates that this process alone would take two months. “The regulators have said they will review all links on a case-by-case basis and that is going to take time,” he said.

Singh added, “Most of us want interoperability as soon as possible but also recognise that the issues are pretty complex to sort out and get the industry to buy into them and the regulators to be in sync.”