The International Swaps and Derivatives Association (ISDA), The Futures Industry Association (FIA) and the Institute of International Finance (IIF) represent the largest number of participants in national and global clearing, banking and financial markets. The Associations appreciate this opportunity to comment on the discussion paper, Financial resources to support CCP resolution and the treatment of CCP equity in resolution.

This response covers the positions of our members on the buy side and sell side. The paper does not reflect the views of many central counterparties (CCPs), and many of the CCPs are in disagreement with the views.

We believe that the five-step process described in the first part of the discussion paper forms a helpful basis for the analysis of the appropriateness of the financial resources of a CCP in light of its recovery and resolution plans. Applying these five steps will highlight that most CCPs will not have sufficient equity or other resources to deal with extreme events, especially for non-default losses (NDL). CCPs should be well capitalized for the risks they face, and the outcome of this five-step process should be to right-size minimum capital requirements. We propose a combination of increased CCP equity and other tools to bridge this gap.

The second part of the discussion paper on treatment of CCP equity in resolution highlights the issue that the exposure of CCP equity to losses in resolution in excess of those to which it would be exposed in liquidation assuming full application of a CCP’s loss allocation rules will likely lead to a ‘no creditor worse off than in liquidation’ (NCWOL) compensation claim, in particular for default losses. This is because in recovery prior to insolvency, at least for default losses, such losses will in most CCPs be allocated to clearing participants (clearing members and their clients). These recovery tools therefore shield the CCP equity (other than the skin-in-the-game (SITG), the amount of CCP funds that are exposed to losses in default management) from losses. As the discussion paper states, for NDL this is less of an issue as the CCP will not be able to allocate many NDL to participants.

We do not agree that the NCWOL safeguard should apply to CCP equity. However, to the extent that it is, we also put forward a solution to the issues that the use of CCP equity for resolution from default losses will likely lead to a NCWOL claim. Clearing participants should receive compensation for the amount of their total losses resulting from the use of recovery tools above default fund and limited assessments (including, for example, variation margin gains haircutting (VMGH) and limited recourse provisions that would operate to extinguish affected clearing participants’ deficiency claims in connection with the closing of a contractually siloed clearing service). This compensation should be senior to CCP equity and entitle the holders to a portion of the CCP’s future income up to the full amount of the loss. Such compensation of clearing participants for losses suffered in recovery as a result of the use of such tools would be fair, as the CCP would not be a viable business without these incremental loss allocations to participants that go beyond the agreed-upon limited assessments. If losses from recovery tools were compensated in recovery with an instrument senior to CCP equity, recoveries in liquidation would go to the holders of those instruments first. It is therefore less likely for CCP shareholders to have a NCWOL claim in resolution if the CCP equity is used in resolution to bear losses.

The discussion paper covers recapitalization of a CCP in resolution. We believe that loss allocation and recapitalization need to be looked at separately. Whoever provides this capital should either receive equity in the CCP or the proceeds from any sale.

Spanning both parts of the discussion paper is the size of the SITG. A CCP should expose a significant part of its capital as part of the default management waterfall so the incentives of the CCP and its clearing members and their clients are aligned. This SITG should be material and dynamically grow with the risk being cleared.

The level of SITG is ultimately a judgement call and is still debated between many CCPs and clearing members. We believe that the optimum level of SITG is difficult to agree between CCPs and clearing participants and ask global regulators to develop standards and guidelines as to sizing SITG for CCPs.

In looking at the financial resources for CCP resolution, we also propose not to look at CCP recovery and resolution in isolation, but to ensure the stability of the whole market and that incentives are aligned between all actors.