US should consider tougher clearing rules

Philip Stafford | Financial Times

The US should consider fresh rules that prohibit clearing houses from pushing any losses from their failure on to pensioners and endowment beneficiaries, a senior US derivatives regulator has said.

Mark Wetjen, a commissioner at the Commodity Futures Trading Commission (CFTC), also suggested authorities may need to consider rules forcing clearing houses to put up more of their own capital to a default fund, and urged greater standardisation over how clearers assess risk in their own systems.

His comments come as regulators worldwide begin to address how the market would cope if a clearing house — designated as a systemically-important institution — failed.

To shore up financial markets, global policy makers decided more of the over-the- counter derivatives market should be processed through clearing houses. The utility-like structures guarantee deals if one side defaults before they are completed.

The question emerging concerns who would take the losses in the event of a failure: the clearing houses themselves; their member banks; investors, such as pension funds; or governments.

One proposal authorities have mooted is allowing clearing houses to apply a “haircut”, or discount, to the variation margins that belong to customers. The margin serves as collateral or insurance for a derivatives trade and is held by the clearing house.

Some investment managers have warned that using such haircuts to margin is tantamount to expropriating assets within a system they were forced into by regulation.

“It’s appropriate to ask whether pensioners and endowment beneficiaries should ever bear this risk of loss when risk management is controlled by the clearing house, its clearing members and other market participants,” Mr Wetjen told the audience at a Futures Industry Association conference in Singapore on Thursday.

“I also believe that we should carefully consider whether customer collateral provided by non-defaulting members to a clearing house should ever be part of a clearing house’s recovery plan, through the use of tools such as variation-margin haircutting,” he said.

He added that removing the risk “would not be inconsequential” and called for the CFTC to lead more public debate on the issue.

Mr Wetjen also used the speech to suggest enforcing clearers to contribute more of their own capital to the fund designed to withstand a default. Users of clearing houses are “members”, with certain responsibilities, such as contributing to a default fund and being prepared to share losses.

The clearing house also contributes to the default fund, although minimum standards of the contributions vary around the world. Some large members, such as JPMorgan and Citigroup, have called for clearers to increase their direct contributions to the guarantee fund or have more “skin in the game”.

Mr Wetjen noted that US rules did not require skin in the game although big clearing houses owned by CME Group and Intercontinental Exchange already contributed to their default funds.

“I believe it would be helpful to ensure clarity for the CFTC to consider a rule addressing appropriate clearing house capital contributions to the default waterfall,” he said.

Read the full in article in the Financial Times here.