The EU Moves to Create Backstop for Clearinghouses to Prevent Systemic Meltdown

In light of BREXIT and whispers of a Deutsche Bank meltdwon, who has $50t in notional derivative exposure, the EU is moving quickly to create a mechanism that will protect and backstop clearinghouses — a move that was roundly opposed by EU banks until now.

Central counterparties (CCPs), such as EMCF, LCH.Clearnet, SIX x-clear and EuroCCP Eurex Clearing, will be provided a backstop that will be funded by member banks.

“Resolution does not aim to prevent the failure of inefficent institutions, rather it aims to maintain the critical functions of an institution, while allowing the remaining parts to be wound down in an orderly manner.”

All clearing houses will have to draw up plans showing how they would recover from a major financial shock. Regulators would be in charge of deciding when to intervene to resolve or close down or restructure the entity, the draft law said.

The draft EU law sets out how regulators should deal with a failing or collapsed clearing house in a way that shields taxpayers without disrupting markets.

It is in the form of a regulation, meaning it will be directly binding on the bloc’s member states, leaving little wiggle room for local regulators. This differs from a similar EU law for handling failing banks which gave countries more leeway.

“Considering their central and growing role in financial markets, all CCPs in the EU are therefore considered to be systemic,” the draft law said.

“As the systemic importance of a CCP failure cannot be determined with full certainty in advance, the proposed framework should apply in principle to all CCPs, irrespective of their size and complexity.”

“This is an area in which there is real UK particularism but with Brexit one can suddenly envisage EU-level supervision, which would be one step against fragmentation in how clearing houses are overseen,” said Nicolas Véron, a senior fellow at the Bruegel think-tank.

“The neat solution would be to have an international level of supervision,” he said, adding though that at present this idea is “about as utopian as it was to talk about European bank supervision 10 years ago”.