Bank of England’s Schooling Latter says central counterparties can be permitted to fail; Ruben Lee says politics will likely undermine efforts to avoid moral hazard, with central banks forced to act
Participants at CentralBanking.com's ‘On Air Debate' today (November 15) sparred over some aspects of the regulation of central counterparties (CCPs), as well as the correct structure for clearing system.
Edwin Schooling Latter, head of the payments and infrastructure division of the Bank of England, said rules around CCP capital requirements were moving in the right direction, adding that a common standard for how the institutions are run across the globe would give "a degree of faith" that can be put "into home country regulations".
Alan Cameron, BNP Paribas Securities Services' head of global strategic broker-dealers and banks relationship management, largely supported the move to CCPs, but said they should be allowed to fail. He said CCPs have gone bust before and will likely default again, so it is important they are regulated strictly.
The panel participants clashed, however, over the role central banks will play in the wake of a CCP default. Cameron said CCPs should be allowed to go bust, to avoid the emergence of a moral hazard, and Schooling Latter said the world of bailout scenarios "has ended". If a CCP defaults, he said, any losses not borne by the defaulter's margin – that cannot be absorbed by mutualised resources it has collected – will fall on its creditors.
But another participant, Ruben Lee, CEO and founder of Oxford Finance, questioned the plausibility of the Bank of England official's attitude, arguing central banks cannot escape to some extent being on the hook, because regulation is not purely a technical activity, but a political one too. As such, any failure will "undoubtedly" lead to political decisions about the extent to which support is provided.
Cameron added that central banks are the only institutions with the ability to provide liquidity to CCPs, and as such the two are "intertwined irrevocably". Schooling Latter firmly restated that taxpayers will not resolve insolvency, and said this was very different from the central bank acting as a ‘lender of last resort' by boosting liquidity in return for appropriate collateral.
Regarding the quality of the CCPs, participants also discussed their ‘qualifying rules'. The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) have produced a list of 24 principles for financial market infrastructures. A CCP must meet all these to ‘qualify' for preferential capital treatment.
If an institution is not going to meet these conditions, it should be clear, said Schooling Latter: "We are not heading towards a world of unpleasant surprises."
There was a greater consensus on the panel regarding the desired number of CCPs in the clearing system. Cameron branded it "overpopulated and over-complicated" from an industry perspective, and said he had lost count of the number of CCPs in the world.
"We have been talking about consolidation as long as I can remember; in actual fact we get proliferation," he said. "When we talk of them as a network, we are exaggerating the effect of this. They're not homogenous and they're not networked."
He added that on an individual level, CCPs are useful, but there is a problem in attempting to access so many, as each has its own rule book and risk criteria. Lee said there would be great efficiency benefits of using a single institution to manage the risk of multiple others, as it could compile much better information regarding all the counterparties trading.
The existence of multiple CCPs could produce an "opaque network nobody understands", Schooling Latter added, and care must be taken to prevent the erosion of risk advantages. "Multilateral netting doesn't work so well if it is spread across a variety of institutions," he added.
Cameron interjected that competition between CCPs has allowed product development and enhancement, a point conceded by Schooling Latter. However, Cameron warned that there is a danger when CCPs compete on how they deal with risk.
Schooling Latter said this highlighted the need for full disclosure. CCPs should compete he said, on dimensions such as the amount of margin they require from participants. In this case, if one is cheaper, it needs to be clear why. In any case, profits cannot be put ahead of systemic risk management, he said.