ECB opinion on derivatives reform spurs debate on CCP liquidity resilience


European regulators have welcomed a European Central Bank (ECB) paper that favours giving central counterparties (CCPs) access to central bank funds in order to clear over-the-counter derivatives.

In an official opinion on the European Commission's (EC) proposed regulation on OTC derivatives, CCPs and trade repositories, dated January 13 and signed by ECB president Jean-Claude Trichet, the bank suggests a crucial change to article 10 of the proposed text, which rules CCPs must have access to adequate liquidity to perform their services and activities, resulting either from "access to central bank liquidity or to creditworthy and reliable commercial bank liquidity, or a combination of both".

But the ECB insists the two sources of liquidity should not be given equal credit in legislation, as central bank funds would probably be a more reliable source of liquidity in a crisis situation.

"The ECB considers that commercial bank money does not truly eliminate risks, whilst central bank money does... therefore, the proposed regulation should not present central bank liquidity and commercial bank money as two equally safe and preferable options," the ECB states.

The statement comes as welcome news to a number of continental European authorities – understood to include French, German, Belgian and Italian regulators – that believe CCPs must have access to the liquidity of central banks. That might encompass anything from intra-day credit to more long-term support during a crisis.

The ECB opinion is a positive development because it states clearly that access to central bank money is best in terms of financial stability. We are pleased that the bank makes the distinction between the risk in commercial bank money compared to central bank money.

"The ECB opinion is a positive development because it states clearly that access to central bank money is best in terms of financial stability. We are pleased the bank makes the distinction between the risk in commercial bank money compared with central bank money. If CCPs are in desperate need of liquidity in a crisis situation, it is less likely they will be able to get it from commercial banks – we need to make sure that difference is properly recognised in the new regulatory system," says Thierry Francq, secretary-general at the Autorités des Marchés Financiers (AMF) in Paris.

While the ECB recognises the superiority of central bank funds as a source of liquidity resilience, it stops short of suggesting central bank support should be a pre-condition of CCPs being licensed to clear OTC products, suggesting it should be left to individual central banks to determine what facilities they wish to offer CCPs, and under what terms.

Although the AMF believes CCPs should be mandated to have more explicit links with central banks, it accepts the ECB's position as the best that could realistically be put forward by the central bank.

"If we had to write something on this issue it would have been more directly in favour of access to central bank liquidity, but, given the necessary prudence and caution of the central banks, this is still a strong message and I think it will be widely heard," says Francq.

The AMF has advocated the importance of central bank liquidity for several months in discussions on derivatives reform and has also suggested CCPs should have access to central bank funds in the same currency as the underlying product being cleared – a rule that might shut non-eurozone CCPs out of clearing euro-denominated swaps and that has been opposed by some CCPs and regulators outside the eurozone, such as LCH.Clearnet in London. Risk previously covered the debate in its January issue: The debate over CCP central bank liquidity

If they fail to convince EU politicians and legislators to include such provisions in the final version of the derivatives legislation, there might be another option. According to industry observers, there has been some discussion of pushing for provisions to be added to the fourth round of amendments to the Capital Requirements Directive (CRD IV) that would require higher capital to be held against exposures to CCPs without access to central bank funds. That would create incentives for CCPs to ensure they have access to central bank funds in order to remain competitive.

Although EU officials working on CRD IV decline to comment, the AMF's Francq confirms it is a possibility. "We still need to discuss some of the issues with our colleagues in bank supervision, but there are certainly two ways to take into account the difference between these two kinds of liquidity – either through rules governing the CCP itself or through the capital charged for the counterparty credit risk inherent in clearing through a CCP without access to reliable liquidity," he explains.


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