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BoE’s Tucker touts CCP mutualisation

Thursday 2 June 2011 – by Nicola York

The deputy governor of the Bank of England says central counterparties should be mutualised to avoid the systemic risk they pose to the financial system if they fail.

Speaking at the DTCC-CSFI post trade fellowship launch in London on Wednesday, deputy governor for financial stability Paul Tucker urged CCPs and regulators to start thinking of clearing houses as systemic and to create a clear resolution framework in order to avoid “disaster” in the event of a failure.

He says: “…it is an understatement that it would be a disaster if a clearing house failed. Commentators have, indeed, been emphasising that CCPs are becoming systemic. To my own way of thinking, they have already been systemic for the markets they clear for a very long time.”

He said that one of two options would be to recapitalise the CCP in the event of a failure so it can carry on operating, but as there are no bondholders, this would have to be done through its clearing members through a pre-programmed allocation of losses.

He says: “A pre-programmed allocation of losses would be akin to the old ‘Down To The Last Drop’ rule that used to be employed by a Chicago clearing house, under which surviving clearing members ultimately had collectively to absorb all losses: mutualisation.”

The second option he proposes is winding down the clearing house’s book which he says would involve a combination of closing out part of the book in the market and putting the residue back to the surviving clearing members. But this is also a variant of the down to the last drop rule, he says.

“Maybe I’ve got this wrong but, in summary, it seems to me that questions about orderly resolution of a failed CCP have to involve clarity around the extent to which surviving clearing members pick up the pieces.”

Tucker cited the “devastating” effects of the failure of the Hong Kong Futures Exchange in 1987 following the global stock market crash, saying this episode would have “entered the folklore of policy memory” if it had taken place in London or New York, and that it deserved more study.

CCPs are not sufficiently recognised as quasi regulatory bodies and must start thinking of themselves as system risk managers, he added.

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