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By Huw Jones and David Henry
LONDON/NEW YORK, May 3 (Reuters) - Global regulators have
proposed tighter scrutiny of clearing houses handling trillions
of dollars in derivatives trades after calls from banks for them
to be better funded to withstand extreme stress.
The Financial Stability Board (FSB) proposed on Sunday a
more detailed checklist for regulators to assess whether
clearers hold enough funds to deal with big losses, and asks
whether there are still gaps to plug.
The FSB coordinates financial rules for the Group of 20
leading economies (G20), which commit to applying them in
national practice. The G20 includes the United States, China,
Japan and Germany.
Clearing transactions in the $640 trillion over-the-counter
(OTC) derivatives market became mandatory after the 2007-09
financial crisis to make trading more transparent.
A clearing house stands between two sides of a financial
trade to ensure its completion even if one side goes bust.
Losses beyond certain limits are typically allocated to
members, such as banks, and in some cases to their clients.
Mandatory clearing has led to a swelling in clearing houses,
with London Stock Exchange's LCH clearing a record $402 trillion
worth of interest rate derivatives in the first quarter.
Such volumes have raised concerns that clearing houses could
put taxpayers on the hook in a crisis or have to draw heavily on
users such as banks.
DEFAULT FUND
The FSB said regulators should analyse arrangements by which
the default fund - the prefunded equity dedicated to cover
default losses - and other minimum financial resources would be
replenished after covering losses.
Clearers have just gone through extreme market volatility
and record volumes without a major hitch as investors sold off
in response to the coronavirus pandemic. Markets face further
stress as the pandemic is likely to trigger a global recession.
The FSB proposal comes amid a years-long standoff between
clearing houses and their customers.
Last month a group of nine global banks and investment
management companies, including JPMorgan Chase, BlackRock,
Citigroup, Barclays and Deutsche Bank, said clearing houses need
to have more of their own capital at risk as an incentive to
limit risky trading.
The group also wants a bigger say in how clearing houses are
run as they worry they will end up plugging the losses if
clearers are not properly resourced.
They argue that the alignment of risk incentives was thrown
out of kilter as major clearing houses shifted to being owned by
investors instead of by their member users.
CME Group, which operates a derivatives clearing house, has
said it is users that bring risk and that they should be putting
money into the default funds.
The FSB paper said regulators should consider whether
clearing houses should hold liabilities that can be "bailed in"
or written down to plug holes from losses, echoing a requirement
for global banks since the financial crisis to shield taxpayers.
(Reporting by Huw Jones in London and David Henry in New York,
editing by Gareth Jones)
