Central counterparties have cheered recent support from regulators on access to central bank deposit accounts and liquidity facilities – but say more needs to be done to make this uniform, including reciprocal access for foreign CCPs, in order to guard against any future liquidity crisis.
“There seems to be a lot of support, not just for systemically important DCOs [derivatives clearing organisations] but other CCPs on getting access to central banks. I hope that we can see some progress in this direction and that there will be some change in the legislation that will allow this to happen,” said Hester Serafini, president and chief operating officer at Ice Clear US. “It’s important not just for the primary currency of your primary regulator where you are based, but any other currencies you may be active in.” Serafini was speaking on a panel at a Futures Industry Association conference in Chicago on October 19.
The issue of CCP access to central bank liquidity was raised at an event held by the Federal Reserve Bank of Chicago earlier in the week, Serafini said, adding there had been “a lot of positive indications” that regulators were taking the issue seriously.
“The general consensus in the room was that you may well have a situation where the clearing members are perfectly solvent – there’s no reason for them to experience stress and undergo a default, and the clearing house may be fine as well – but it’s just a matter of sourcing the cash and getting the cash in time to meet those variation margin calls that are on very tight schedules. Having some flexibility around that, where potentially a form of collateral could be used, posted at the central bank and some cash comes out… is very important for the soundness of the clearing system,” she said.
The issue of CCP liquidity risk came to the fore in June 2016, when the sharp market falls that followed the UK’s shock vote to leave the European Union prompted CCPs to issue margin calls totalling a combined $40 billion in the days that followed.
At the time, some clearing members accused LCH, the market’s largest interest rate swaps clearer, of being slow to return dollar cash collateral posted to cover margin calls, which they claim increased their funding burden at a time of stress. Members say that, in part, the issue stems from LCH lacking a dollar deposit account with the Federal Reserve, as most US CCPs enjoy, forcing it to reinvest cash collateral received in the repo markets rather than leaving it on tap at the central bank. The CCP must then wait for the reverse repo to be unwound before it gets the cash back.
Eric Mueller, chief executive officer at Eurex Clearing – who was also present at the Chicago Fed conference – stressed that while CCPs have a road map for how to behave in recovery and resolution scenarios, they often lack a blueprint for coping with liquidity issues – something that needed to be addressed.
“[There is agreement] that liquidity is the key aspect of [CCP] risk management, because we are going to see liquidity issues way before we exhaust the [default] waterfall or even talk about resolution scenarios,” he said, speaking on the same panel as Serafini.
At present, a patchwork of rules govern CCP access to central bank resources. In the US under the Dodd-Frank Act, CCPs labelled systemically important financial market utilities may establish Federal Reserve accounts to deposit funds with the central bank’s blessing. However, these accounts cannot be used to borrow from the Fed. The central bank can only extend liquidity to a Sifmu in “unusual or exigent circumstances” once all other attempts to tap private credit are exhausted and following an affirmative vote of the board of governors.
CME Group, the Options Clearing Corporation, Ice Clear Credit and DTCC are all designated Sifmus, among others – but Ice Clear US is not. The lack of access in part prompted Ice to make a change to its rule book earlier this year to force members to post more cash in US dollars, to shore up its liquidity position.
The US Treasury report on capital markets, published on October 6, recommended the Fed review the risks inherent in barring access to central bank deposit accounts for CCPs with significant shares of US clearing business and find “an appropriate way to address any such risks”, which implies that access could be expanded beyond systemically important firms.
On the other side of the Atlantic, Eurex in Germany and LCH SA in France are required to hold banking licences which permit them to park cash at the respective central banks. However, this also means that, as the rules stand, they will have to comply with the liquidity coverage ratio and net stable funding ratio enshrined in the revised Capital Requirements Regulation once the legislation is finalised.
Eurex’s Mueller said he was hopeful an exemption would be granted before CRR II is finalised: “There are some things that need to be fixed. The European Banking Authority and European Securities and Markets Authority have made recommendations, so I think that’s firmly on the agenda. This [central bank access] should really be outside the rule book for banks.”
The European Market Infrastructure Regulation pushes CCPs to invest 95% of received margin and default fund payments into deposit accounts or government bonds. Mueller noted that if CRR II applied, cash parked in central banks would inflate leverage ratio exposure and incentivise CCPs to turn to securities for these payments instead – storing up liquidity issues for the future.
In the UK, the Bank of England exempts reserves held at the central bank from the leverage ratio, but that move has not been followed by other European regulators. More than half of Eurex Clearing’s assets were held at the Bundesbank, according to its annual report.
Sunil Cutinho, president of CME Clearing, said on the same panel that exemptions from banking rules should apply because of the very different nature of CCP access to the Federal Reserve from that granted to commercial banks.
“These accounts cannot be overdrawn – they are just a safe deposit for cash. This is not like a reserve account where we are lending money, so in terms of functions this is completely different,” he said.