Thomas Murray comments to FSB on CCP Resolution

Given Thomas Murray’s expertise in post-trade services, it was incumbent upon the firm to respond at length to the Financial Stability Board’s Discussion Note on resolution of CCPs, dated August 2016. This posting is excerpted from the full response, which will be posted on the FSB website in due course.


Since the 2009 G20 Pittsburgh Communique, which unexpectedly put heavy reliance on central counterparty clearing to “solve” the risks inherent in over-the-counter derivatives, analysts here have examined the potential effects of this policy objective step-by-step.  The firm’s clients count on its guidance in the risk assessments we provide. No matter what the market conditions, trades must be cleared, even if an infrastructure is being closed down.

CCP structures and operations have been transformed since 2009 to meet the new mandate set by G20, and the OTC mix has begun to be added in size into CCP books. The risk managers seem to be handling the changeover. This firm, however, remains very concerned by the cost transfers from the bilateral contracting parties to the CCPs, making them much more expensive to use; and also by falling liquidity and shrinking collateral pools due to other regulatory changes in the financial system. A significant drop in liquidity is one of the worst indicators for the health of a capital market – in medical terms, this would be a patient running a high fever. This is not a favourable evolution of business.

Risk management in a CCP does not eliminate risk; it mutualises bilateral counterparty risk for the duration of the contract. The costs of risk have been moved laterally to a more public venue.

In 2009, the CCPs of the world did not collectively put their hands up to volunteer to take on the responsibility for OTC counterparty risk management. If memory serves us correctly, other actors in the financial marketplaces instead volunteered the CCPs. Many read the CCP solution to OTC as, effectively, the end of the bilateral contracts position problem – Thomas Murray did not.  That baseline of understanding of what happened then, and why, remains critical to public assessments of how these infrastructures will behave in this new environment.

General observations on the consultation

In the text, there are several passages that refer to resolution in which the reader appears to be guided back to recovery. Certainly, recovery would be preferable to the need to wind down a market infrastructure – but guidance by the public authorities will have to be clear that beyond a certain point there can be no going back. Resolution is the term used in the name of this FSB Discussion Note. Once the decision to resolve a CCP is taken, the mechanism must be irreversible and known to be so. The text appears to waver on this point. In fact, Thomas Murray would strongly recommend ending the usage of “recovery and resolution” as a single term. The two questions need to be distinguished at every level, beginning with the language used.

There is an evident need to set out the guidelines for the moment of determining that recovery of a CCP will no longer be possible, and that the switchover to resolution becomes inevitable. It would be an extraordinarily difficult decision to take.

There is appropriate emphasis on sharing losses during resolution.

The FSB Note is less clear how the clearing function would continue during resolution and who would be in charge of clearing operations. Do the public authorities charged with the responsibility of oversight have the expertise required to continue the clearing function? Should there not be provision for this, possibly including training, that is publicly communicated as an assurance to the market? Should the resolution authority create a new entity for this function, operated by it, with the explicit intention of privatising it as soon as market conditions will allow? In this sense, there may be a parallel to the “bad bank” resolution authority system, in which the loan portfolios are progressively wound down. There is a moral hazard element in stating at the outset that the government will back clearing, but that is the logical end to the G20 decision – and probably the less costly solution for taxpayers, anyway.

Even with proper training by others, the problem of porting positions to a new clearing facility must be solved. There are legal property issues that need to be addressed, as well as the difficulty of lining up in advance a second, back-up CCP having to bear the costs of standing availability – and then, suddenly, to receive positions at what would inevitably be an extraordinarily difficult moment for the markets. This, in the firm’s view, is the other subject area which remained too vague or entirely unstated in this Comment Note.

As matters stand, for this one critical function, the world’s financial system has become terribly dependent on the continued operation of half a dozen very large CCPs. To reduce that dependency, other actors must be trained to pick up the strands of a fraying system, if it were to come to that. And it would be helpful for the market to know that the national resolution authority would be on stand-by for continuing operations. The choice for the authorities is not an easy one: but, it seems to us that the moral hazard question has long been on the table. Was it not always implicit from 2009 in Pittsburgh, when so much OTC contract counterparty risk got switched from the banks to the capital markets? Was it not also implicit in the government backing of the bank-members of CCPs? The CCP and its members are a single intertwined unit, with public support implicitly given to varying extents.


The CCPs assessed by Thomas Murray believe they have solid recovery plans in place, given the sort of very worrisome foreseeable scenarios coming together as the basis for stress testing. That is truly all that can be asked of these institutions. Further, the measures already taken to shore up CCPs since 2009 have been costly for the clearers and their clients, though necessary for meeting the demands of taking OTC contracts on the books. If, even after all this preparation, measures to recover a CCP in difficulty fail, the resolution authority must be immediately ready and able to assure continuity of clearing.

The FSB is to be commended for taking these first steps in airing these questions. It is most helpful that the title to the Note refers only to resolution. We reiterate that the FSB and national authorities would do well to drop usage of the mixed term of “recovery and resolution,” in order to specify on which side of the recovery /resolution question one finds oneself. The clarification of roles under each regime must first be distinguished and then detailed - separately.

To the extent possible, resolution of a CCP should be handled in a manner analogous to corporate bankruptcy proceedings, and the precedents established by resolution of other financial institutions – with the caveat that marketplaces usually have multiple banks or brokerages or insurance companies, but most of the time only a single CCP. There would not easily be a hand-off of the clearing function other than to the resolution authority itself, and without clearing all trading would come to a halt.

Moral hazard cannot be eliminated. Its effects must be minimised, however; a balance will have to be struck by the resolution authority between showing enough in the way of guidance so that there will be assurances of business continuity whilst not underwriting unduly risky behaviour on the part of market participants. No one would expect such choices to be easy.


Thomas Murray’s view is that more explicit guidance on how the authorities would proceed on resolution needs to be given now for the CCPs and their stakeholders to define their own resolution planning in greater detail, so that it responds to and fits that public planning. The authorities need to be leading this work; they would be leading in resolution, too.

Tags: Financial Stability BoardCCPCCP Resolutionpost-trade servicesderivatives