Central counterparties in evolving capital markets: safety, recovery and resolution

Capital markets – whether for raising funds or transferring risk – are a vital part of financial system. Perhaps even more so in the years ahead as banking is reregulated. The international authorities are working together to simplify the network of transactions by mandating that standardised over-the-counter (OTC) derivatives are centrally cleared. That entails a concentration of risk around central counterparties (CCPs) and so relies upon them being safe and sound. CCPs’ risk management is a first line of defence: managing clearing-member positions to reduce the likelihood of default; ensuring financial mitigants to cover potential losses are adequate. Should mitigants be exhausted, CCPs need a comprehensive recovery plan, including ex ante arrangements to mutualise emaining losses amongst surviving members. In case the plan fails, the authorities must be able to resolve a CCP safely without recourse to public funds.