Wednesday, September 29, 2021
I had a chance to read Chapter 7 on Clearinghouses [CCPs] in a recent report by the Task Force on Financial Stability and look forward to reading more of the report soon. It’s a short chapter with a lot of excellent information. I particularly appreciated its focus on the issue of clearinghouse ownership (too often left out of clearinghouse discussions), incentive misalignments, and tensions between shareholders and clearing members when CCPs are for-profit, public companies. There is an especially helpful discussion on externalities in the current clearing ecosystem and a summary table of them accompanied by related recommendations (p.99). I agreed with several of the chapter's recommendations (starting on p.96) and with the statement that “Pervasive reforms of derivatives markets following 2008 are, in effect, unfinished business; the systemic risk of CCPs has been exacerbated and left unaddressed” (p.96).
On p.94, the report mentions that clearing members “complained when, in December 2017, the CBOE and CME listed bitcoin contracts (which have extremely high volatility and which many members were not authorized to transact) and then commingled the contracts with the default fund for other instruments.” I think the complaints are understandable and pointed out this issue in a previous post (here).
I did have feedback about a few items in the chapter and will share two points:
First, on p.93, the report states “Were a CCP to fail, something that has not yet occurred, the disruption to the financial system could be enormous.” It’s certainly true that a failed, significant CCP would likely cause enormous disruptions in financial markets. However, as I note in my 2016 report for the Volcker Alliance (p.52), CCPs have failed in other countries and some have argued that certain CCPs in the U.S. risked failure in the October 1987 crash.
Second, I’d like to see a lot more discussion of recommendation #3 (p.97):
“Make sure that systemically important CCPs outside the United States have access to a lender of last resort who can provide dollar funding. This might be provided through a foreign central bank that is willing and able to lend and has access to a Fed swap line. If such funding is not available, and conditioned on a Fed finding that a non-U.S. CCP is adequately supervised, the Fed should consider extending access to the discount window to systemic non-U.S. CCPs. (Currently access is restricted to FSOC-designated systemically important financial market utilities.) It is in the United States’ interest to prevent the failure of systemic CCPs around the world. If a properly supervised entity needs access to dollar funding, and satisfactory information sharing is in place to limit risk, discount window access would strengthen the system.”
In The Federal Reserve's Use of International Swap Lines, I noted that from my perspective, certain provisions in Dodd-Frank appeared to anticipate the possibility of Fed swap lines with CCPs outside the U.S. (p.648). The risk of potentially having to provide emergency euro funding to clearinghouses outside the Eurozone has been an important aspect of the longstanding tensions between the U.K. and the E.U. surrounding clearing (a few stories on this are here, here, and here). The E.U. has argued that because of this financial stability risk, such clearing should be relocated to the Eurozone. Hence, the issue of a major central bank having to provide emergency funding to a foreign clearinghouse is a highly significant concern and merits extensive discussion.