In response to reports that the European Commission
("EC") is finalizing legislation on Central Counterparty
("CCP") recovery, University of Houston Finance Professor
Craig Pirrong outlined the
sources of "fundamental tension" that underlie the final
resolution authority. Citing a statement in the EC's Executive
Summary Sheet that the contemplated framework is likely to involve
"a public authority taking extraordinary measures in the
public interest, possibly overriding normal property
rights and allocating losses to specific stakeholders"
(emphasis supplied), Professor Pirrong concluded that the prospect
of trampled rights "calls into question the prudence of
creating and supersizing entities with such latent destructive
Professor Pirrong argued that the resolution authority
potentially will "impose large costs on members of CCPs, and
even their customers, [which] raises the burden of being a member,
or trading cleared products," and consequently,
disincentivizes membership. He also asserted that "[t]he
prospect of dealing with an arbitrary resolution mechanism will
affect the behavior of participants in the clearing process even
before a CCP fails, and one result could be to accelerate a crisis,
as market participants look to cut their exposure to a teetering
CCP, and do so in ways that push it over the edge."
According to Professor Pirrong, the irony is that these measures to
protect CCPs will lead to a "reduced supply of clearing
services, and reduced supply of the credit, liquidity and capital
that [such CCPs] need to function."
In addition, Professor Pirrong cautioned that with discretionary
power comes "inefficient selective intervention" and the
potential to influence costs. "[T]his makes it
inevitable," he warned, that the body will be subjected to
intense rent-seeking activity that will mean that its decisions
will be driven as much by political factors as efficiency
considerations, and perhaps more so: this is particularly true in
Europe, where multiple states will push the interests of their
firms and citizens."
speech delivered five years ago on "Clearinghouses,
Financial Stability, and Financial Reform," then-Fed Chairman
Ben Bernanke declared that "[i]f you put all your eggs in one
basket, you better watch that basket." However, putting all of
the risks of over-the-counter derivatives into a small number of
CCP baskets will require a lot more from regulators than merely
watching those baskets. In the aftermath of the financial crisis of
2008, clearinghouses have been charged with the task of curtailing
risk in this new market – a task that they may not be able to
fulfill, given the high values and long maturities of such
instruments as compared to other cleared contracts. (Jo
Braithwaite, Legal Perspectives on Client
Clearing (LSE Legal Studies Working Paper No. 14/2015,
2015), quoted in Hester Peirce, Derivatives
Clearinghouses: Clearing the Way to Failure, 64 Clev. St. L.
Rev. 589, 605 n.71 (2016).)
One of the notable aspects of clearing member insolvency has
been the ad hoc application and arbitrary nature
of making customers whole, notwithstanding the CEA and the
Bankruptcy Code's regulatory framework for dealing with such
situations. By contrast, an insolvency involving a clearinghouse is
several magnitudes greater. A glance at the regulatory framework
for CCPs that is being contemplated by the EC inspires even less
confidence that recovery and resolution following a CCP failure
will be any less arbitrary.
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