Given the evolution of derivatives markets since the financial crisis, there needs to be greater focus on ensuring the viability of central counterparties (CCPs), according to the International Swaps and Derivatives Association, Inc. (ISDA).
The ISDA has published a new set of principles on the adequacy and structure of central counterparties’ resources for absorbing losses, and on the recovery and resolution of these critical infrastructure firms. The paper makes several recommendations on how to address certain issues associated with CCPs.
Among other things, it calls for greater transparency in the risk management standards, practices and methodologies used by CCPs to calculate their loss-absorbing resources; mandatory, standardized transparent stress testing; and, aligning the incentives of CCP management with the firms that clear trades through the facility. It also calls on CCPs to have clearly defined and transparent recovery plans.
The ISDA notes that clearing houses “have become a crucial part of the derivatives market infrastructure”, particularly in the wake of post-crisis regulatory reforms, such as new requirements that standardized over-the-counter (OTC) derivatives be centrally cleared. “With the volume of cleared trades increasing rapidly and certain to grow further, these entities have become systemically important,” it notes.
As a result, the ISDA says that it believes that “particular attention needs to be paid to ensuring the risks of a CCP reaching the point of non-viability are minimized.” And, if a clearing firm does reach the point of failure, it says that a clearly defined recovery plan needs to be in place that does not involve the use of taxpayer money.