On 8th May 2018, CPMI-IOSCO released anonymised updates on the three critical risk areas where central clearing houses are scrambling to meet the business and regulatory demands as set forth in the 2014 Principles for Financial Market Infrastructures (‘PFMIs’). These three are recovery, coverage of financial resources, and liquidity stress testing.

In April, the global banking and capital markets authorities together announced a mid-course correction to their work transforming central counterparty clearing of OTC derivatives contracts. In their search in 2009 for the answer to the ‘OTC counterparty risk problem’ that had so brutally hit the world’s financial system and economy, the authorities grasped at a notion then circulating in central banking circles: if clearing houses had proven themselves able to manage the risk of on-exchange transactions during the market turmoil of 2008 and the failure of Lehman Brothers, then they ought to be called upon to do the same for the off-exchange business that had gone off the rails.

A key objective for G20 countries announced at their Pittsburgh Summit in 2009 was to reduce systemic risk in the global financial system by moving over-the-counter (‘OTC’), bespoke derivatives into central clearing houses. The bilateral risk is assessed and taken onto the books of the CCP for the entire life of those instruments. To achieve that level of risk management over the entire term of each contract, the OTC contracts had somehow to be standardised, which by definition is a contradiction with their specific, tailored nature and purpose. It was always going to be hard to square that circle; the CCP segment was not made for this purpose.

Agreed and launched in 2012, the CPMI-IOSCO Principles for Financial Market Infrastructures (‘PFMIs’) require that all central securities depositories (CSDs), central clearing houses (CCPs), payment systems, and trade repositories perform a very detailed self-assessment of how well they observe these global standards. The self-assessments are meant to be published as a matter of enforcing transparency on these systemically critical systems, and also to reassure the markets and public that these national institutions are meeting a consistent set of minimum standards. The PFMIs are one set of the body of standards orchestrated by the Financial Stability Board on behalf of G20 governments.

Possibly the most complex piece of capital markets legislation to hit the markets since the Dodd-Frank Act in the US in 2010 is nearly upon us, the European Union’s revamping and extending of the Markets in Financial Instruments Directive (MiFID I) promulgated in 2004, with effect in November 2007. That was one very long decade ago, given events in financial markets over the period.

Financial market professionals working in the EU and outside it will be affected, some heavily. Its immediate, most visible impacts are on transaction order transparency pre-trade, transaction reporting post-trade, and the separation of research from bank/broker trading commissions. The changes will likely go further: as with most rearrangements in the intricate chains of financial services, there will be knock-on effects beyond the immediate targets of the authorities, though what they will be is hard to define beforehand.


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