Explanatory Memorandum to COM(2016)856 - Framework for the recovery and resolution of central counterparties - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2016)856 - Framework for the recovery and resolution of central counterparties. |
|---|---|
| source | COM(2016)856  |
| date | 28-11-2016 |
1. CONTEXT OF THE PROPOSAL
1.1.Reasons for and objectives of the proposal
A central counterparty (CCP) intervenes between participants in financial markets to act as the buyer to every seller and the seller to every buyer for a specified set of contracts. CCPs deal in financial transactions in various asset classes such as in equities, derivatives and repos. Their services are usually provided to their clearing members (typically banks) who have a direct contractual link with CCPs and the clients of the clearing members (e.g. pension funds).
The concentration of transactions and resulting positions in CCPs allows those positions to be netted down and therefore considerably reduce total exposures of the CCP, as well as of its clearing members and their clients. In exchange for taking on and netting their positions, the CCP collects collateral (in the shape of ‘margin’ and contributions to default funds) from clearing members and their clients to cover its liabilities in case one of its participants defaults on its obligations vis-à-vis the CCP. By doing so, they manage the risks inherent in financial markets (e.g. counterparty risk, liquidity risk and market risk), and therefore improve the overall stability and resilience of financial markets. In the process, they become critical nodes in the financial system, linking multiple financial actors and concentrating significant amounts of their exposure to diverse risks. Effective risk management of the CCP and robust supervisory oversight is therefore key to ensure that such exposures are adequately covered.
The scale and importance of CCPs in Europe and beyond is set to increase via the implementation of the G20 commitment to clear standardised derivatives transacted over-the-counter (OTC) through central counterparties. This obligation is implemented in the EU by the Regulation on OTC derivatives, central counterparties and trade repositories (‘EMIR’) 1 . That Regulation also sets out comprehensive prudential requirements for CCPs, as well as requirements regarding the operations and oversight of CCPs.
While CCPs in the EU are thus subject to high standards in view of their central role in the economy and of the added risks they are assuming, no harmonised EU rules exist for the unlikely situations in which these standards would be overwhelmed and in which CCPs would face severe distress – beyond that envisaged by EMIR – or outright failure. In principle, failing corporations should be subject to insolvency proceedings. However, the past crisis clearly illustrated that the failure of an important financial institution which is highly interconnected with others in financial markets can cause critical problems for the rest of the financial system and negatively impact prospects for growth across the wider economy. This is because their insolvency may abruptly curtail the provision of an institution’s critical functions to the economy, triggering market panic and contagion due to counterparties and investors being unsure about their assets and liabilities in drawn-out legal proceedings. Faced with this threat to financial stability, caused for example by lack of confidence in the market, and the overall public interest, governments have often been compelled to bail out failing financial institutions with public money to prevent this from happening.
Recovery and resolution constitute measures that aim to safeguard financial stability, ensure the continuity of critical functions and protect taxpayers in the event of the distress or failure of an institution that is experiencing financial difficulties, where insolvency proceedings would be insufficient to meet these aims. As such, the measures are designed to protect vital critical functions without exposing taxpayers to loss in order to preserve the ability of the financial system to fund economic growth and avoid the socio-economic costs of a financial meltdown. Recovery and resolution measures are most relevant where a financial institution is “systemic”, whereby because of its size, market importance and interconnectedness, for example, its distress or disorderly failure would jeopardise the normal functioning of the financial system, which would in turn adversely impact the real economy.
While CCPs are already well-regulated, have robust resources to deal with financial distress under EMIR and have not undergone distress or failed in large numbers in the past, the challenge posed by their growing importance in processing increasing amounts of new types of risk is widely recognised by governments, authorities and other market participants. Considering their central and growing role in financial markets, all CCPs in the EU are therefore considered to be systemic 2 .
Recovery measures are those which a financial institution itself takes to restore its long-term viability. Ensuring the right conditions for recovery measures to succeed is a key policy objective for CCPs, as their failure is considered to be potentially highly disruptive for the wider financial system. However, authorities acting in the public interest should also have powers to resolve a CCP if these measures fail or could damage financial stability. Resolution measures constitute extraordinary steps which authorities would be able to take to swiftly restructure CCPs and secure the continuity of their functions that are critical to the economy, thereby mitigating the damage to the financial system and the broader economy, while placing the residual parts of the CCP in insolvency, ensuring market efficiency. In the process, costs and losses are imposed as far as possible on the CCP’s owners and creditors, not the taxpayer, in line with how they would be treated if the CCP had entered insolvency and in full respect of the Charter of Fundamental Rights, the relevant case-law of the Court of Justice of the European Union, and the European Convention on Human Rights. Resolution does not aim to prevent the failure of inefficient institutions; rather it aims to maintain the critical functions of an institution, while allowing the remaining parts to be wound down in an orderly manner.
The analysis for the need to respond to the possible recovery and resolution of other financial firms than banks and CCPs has not progressed at the same pace. This is mainly due to the lessons learned during the financial crisis which did not demonstrate an equally urgent need for such measures. However such measures may be necessary in the future, taking account of the development of economic and financial risk in the sectors concerned.
Furthermore, specific and wider international work on insurance undertakings at G20-level is also in its relatively early stages of recommendations and few jurisdictions have on practice introduced regulatory reform in this area. Within the EU, to date three Member States have introduced legislation on the recovery and resolution of insurance undertakings or are in the process of doing so. EIOPA has engaged in a thorough, comparative and wide-ranging review of national recovery and resolution practices and developments in this area and is set to present a report on this topic in the first half of 2017. On the basis of that report, the Commission will consider the appropriate way forward, in close consultation with the European Parliament, Council and all relevant stakeholders.
1.2.Consistency with existing provisions in the policy area
A comprehensive EU recovery and resolution framework has already been adopted for banks and investment firms 3 . The proposed framework for CCPs neither duplicates this regime nor the requirements of EMIR but complements them. It sets out provisions comparable to those in the framework applicable to banks and investment firms to facilitate orderly recovery and resolution, but adapts them to the specific features of CCPs’ business models and the risks they incur, including by determining how losses would be shared in scenarios where existing CCPs’ pre-funded resources required under EMIR are exhausted.
More broadly, at the international level, G20 leaders have endorsed an approach developed by the Financial Stability Board (FSB) to address the risks which the failure of any financial institution (bank, financial-market infrastructure, insurance undertaking, etc.) of global systemic relevance could have on the financial system via comprehensive and appropriate recovery and resolution tools 4 . Furthermore, the Committee on Payment and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO) have developed guidance on recovery plans for financial-market infrastructures, including CCPs, while the FSB has issued further guidance on the application of its Key Attributes of Effective Resolution Regimes to financial market infrastructures, such as CCPs, as well as insurers 5 . In mid-2016, these organisations consulted further on key parts of this guidance, including on issues such as the timing of when resolution authorities should place a CCP into resolution because its viability and financial stability are at stake, and which powers and tools the resolution authority should employ at this point to best secure the continuity of critical functions, minimise contagion and allocate costs and losses in the most efficient way possible 6 . Finally, in December 2013 the European Parliament adopted an own-initiative report calling on the Commission to propose appropriate EU measures to ensure that the impacts of a potential failure of key financial institutions, most notably CCPs, could be mitigated 7 .
1.3.Consistency with other Union policies
A proposal to create a European framework for the recovery and resolution for CCPs was signalled in the Commission’s Work Programme for 2015 and a roadmap on the initiative was published in April 2015 8 . In order to take account of the further refinement of the relevant international guidance mentioned in the previous section, the initiative was carried over into the Work Programme for 2016. The initiative is part of the Commission’s efforts to ensure that threats to the smooth functioning of the financial system and to taxpayers are tackled and that financial markets can continue to play their role in contributing to sustainable, long-term growth to further deepen the internal market in the interests of consumers and businesses.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
2.1.Legal basis
The legal basis for this proposal is Article 114 of the Treaty on the Functioning of the European Union (TFEU), which allows the adoption of measures for the approximation of national provisions which have as their object the establishment and functioning of the internal market.
The proposal harmonises national laws on recovery and resolution of CCPs to the extent necessary to ensure that CCPs are subject to similar tools and procedures to address their possible distress or failure. At present, while authorised CCPs are able to operate and provide services across the EU, the regulatory landscape for managing potential crises exceeding the requirements of EMIR is fragmented. Some Member States have enacted requirements for CCPs to prepare contingency plans against their distress or cover CCPs as part of broader resolution regimes for the financial sector designed primarily for banks. No Member State has yet developed a full national regime for CCP recovery and resolution which fully complies with the G20-endorsed FSB principles, including as regards the need for effective coordination and oversight against cross-border spill-overs 9 . Without an EU-level framework, Member States are unlikely to develop comprehensive and compatible regimes. The divergent approaches by which CCPs and authorities would mitigate or tackle CCP distress or failure would not be fully coherently planned and could be inconsistently applied. This could lead to the disruption of critical functions to clearing members and clients across borders and to wider financial instability. EU level action is therefore necessary to adequately equip Member State authorities with tools and powers that would be enforced in an expedient, coherent and equal fashion across the Union.
EU-level action is warranted also for CCPs that have fewer direct cross-border links, but where harmonisation would mitigate possible level playing-field and competition concerns arising from the prospective and actual national handling of a CCP failure. For example, national regimes with different degrees of potential state intervention with public funds would result in an un-level playing-field in favour of those CCPs based in Member States where support is more likely. The experience with bank failures in different Member States underlines how problems at systemic financial institutions can fragment the Single Market into national economic zones. Market perceptions and biases in favour of entities located in jurisdictions with relatively stronger implied backing by the state can cause competitive distortions and arbitrarily influence costs for businesses depending on their geographic location and the perceived appetite of, or necessity for, a Member State to pre-emptively ring-fence assets, liquidity or capital to minimise cross-border exposures. While the risk of this type of fragmentation of the Single Market in case of CCPs is less imminent, differing perceptions and uncertainty over the ability of Member States to take control of a failed CCP and resolve it effectively could undermine market participants' trust in and thereby the integrity of, the functioning of the Single Market. Indeed, the uncertainty over how the failure of key market infrastructures could be managed in the absence of common EU-rules is cited as one reason for the lag in the pace of integration in Europe’s capital markets 10 .
The harmonisation of requirements applicable to CCPs would improve the level playing-field for economic operators and help boost the integration of the internal market. By ensuring that all relevant Member State authorities have the same minimum tools to ensure the orderly recovery and resolution of CCPs and by facilitating cooperation between authorities, so as to mitigate any cross-border spill-over effects when dealing with their distress or failure, the harmonised framework would also enhance financial stability across the internal market and prevent outcomes in which Member States would be compelled to act alone, and in uncoordinated fashion, in relation to operators established in their jurisdiction.
Article 114 of the TFEU is, therefore, the appropriate legal basis.
2.2.Subsidiarity
Under the principle of subsidiarity set out in Article 5(3) of the Treaty on European Union (TEU), in areas which do not fall within its exclusive competence, the Union should act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.
EU financial markets are open and integrated. CCPs are able to operate cross-border within the markets and product lines they serve. In the process, they link multiple financial actors, counterparties and clients across borders throughout the single market. Due to this advanced and multi-layered cross-border integration of the financial sector, an EU resolution and recovery framework is needed that mirrors the level of integration of the business. Current tools to deal with CCPs that face a crisis are limited to CCPs’ internal arrangements or are, where developed, nationally based. This means that there are potentially divergent approaches by which CCPs and authorities mitigate or tackle the problems within a CCP facing financial distress or on the verge of failure, which could ultimately lead to the disruption of critical functions for the economy, fragmentation of the internal market and wider financial instability. The failure of a CCP operating beyond national borders, which is true of the majority of cases, is likely to affect, to differing degrees, the stability of financial markets in the Member States in which it operates. Only EU action can ensure that CCPs and their clearing members (which can be located in different Member States to the CCP) are subject to adequate and effective intervention to mitigate or address a crisis situation in a coordinated and coherent manner. Therefore, to secure these objectives at the Union-level and at the level of Member States, it is appropriate that the Union should develop the necessary legislative framework.
2.3.Proportionality
Under the principle of proportionality, the content and form of Union action should not exceed what is necessary to achieve the objectives of the Treaties. In principle, a failed CCP should be subject to insolvency procedures like any other business. However, CCPs are central financial infrastructures which are highly interconnected with, and centralise risk on behalf of, myriad financial actors. As such, depriving these actors of the critical services provided by a CCP could create serious consequences for financial stability and the wider economy. To mitigate this, it is justified to require adequate contingency plans for orderly recovery and resolution and to grant authorities resolution powers to swiftly restructure their operations if necessary.
As the systemic importance of a CCP failure cannot be determined with full certainty in advance, the proposed framework should apply in principle to all CCPs, irrespective of their size and complexity. The majority of CCPs established in the EU provide services to clearing members and clients across the EU and some beyond, and their distress or failure could thus resonate globally. Recovery and resolution plans should thus be tailored to the specific risk-profile of each CCP. The exercise of any extraordinary actions by the authority to preserve financial stability and protect taxpayers would also always have to be fully justified and proportionate, not go beyond what is necessary to achieve the objectives, and be consistent with the Charter of Fundamental Rights as interpreted by the Court of Justice of the European Union as regards any limitations to the right of property which the powers may entail. Finally, they would be conducted in such a way as to ensure that affected stakeholders are treated no worse than if the CCP had not been resolved but would have been subject to further possible actions under the CCP's operating rules for allocating losses or gone into insolvency.
2.4.Choice of instrument
Article 114 TFEU allows the adoption of acts both in the shape of Regulations or Directives. The adoption of a Regulation is retained here for the following reasons.
First, a Regulation would best complement and build on the approach established by EMIR which provides the requirements for CCPs in the field of prudential regulation. The new requirements for CCPs to set out comprehensive recovery arrangements build on the objectives and provisions of EMIR to ensure that CCPs are resilient. Setting these out in another legal form (namely a Directive) would be inconsistent and require Member States to adopt laws in a specific part of an area otherwise governed by directly applicable EU law. The provisions for authorities to have targeted powers and tools to carry out, where necessary, effective and orderly resolution to maintain financial stability if the requirements under EMIR and the recovery arrangements fail are no longer concerned with furthering the going-concern resilience of CCPs but do involve securing the viability of their critical functions in a way whereby operation of these functions (in the same legal entity or in another form) continues to meet the requirements and objectives of EMIR. Accordingly the provisions governing how to achieve this should be framed in the same legal form as EMIR.
Second, a Regulation would best deliver a common approach and a single rulebook for authorities and would avoid divergence between national rules and the possible legal uncertainties which this can entail notably in cross-border contexts as outlined above. It would also facilitate international cooperation, where relevant, and make it easier to do business with and in the EU, as the system in the EU would be uniform. Moreover, considering that the impact of a EU CCP failure could potentially have consequences for the financial system of all EU Member States, such a uniform framework would alleviate any damaging uncertainties about the conditions in which such a failure would be dealt with by the relevant authorities of CCPs in different Member States and help reassure stressed markets.
Third, because of their business models the likelihood of a CCP failure is generally understood to be far lower than for banks. In contrast to banks of various sizes and risk profiles, the failure of which can arise in different scenarios, assume varying proportions and consequently require a wider array of resolution tools (and derogations), CCP-failure is more likely to occur for reasons which are known upfront (defaults by clearing members or severe operational failure) and which can be managed with a more distinct set of tools. Therefore, this more limited applicability and need to cater for as large a variety of options entails that the objectives can be better served via a Regulation, albeit that some flexibility is necessary to allow authorities to react to the circumstances of the case.
Finally, compared to EU banks EU CCPs represent a far smaller number of entities and the corporate structures of CCPs and the way in which they provide services across borders differ from those of cross-border banking groups. In the latter case, subsidiaries and branches are often set up in various jurisdictions to serve customers, acquire assets, obtain funds etc., justifying a greater degree of sensitivity for local laws in the implementation of resolution decisions. In the case of CCPs, the provision of services happens in a less dispersed way, centrally from one jurisdiction into others without the intermediation of subsidiaries or branches. This favours adopting a Regulation to ensure the uniform application of decisions across jurisdictions.
3. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS
3.1.Stakeholder consultation
A public consultation on a possible recovery and resolution framework for non-bank institutions 11 was carried out between 5 October and 28 December 2012. It asked questions about the need for recovery and resolution arrangements mainly in relation to CCPs, central securities depositories and insurance undertakings. 67 replies were received 12 .
On the whole, the consultation indicated that the priority should be to develop an EU-wide recovery and resolution framework for CCPs. The implementation of the G20 requirement for standardised OTC derivatives to be centrally cleared was recognised as a compelling argument in favour of taking action. Respondents generally agreed that, like the BRRD for banks, a framework for CCPs should ensure continuity of their critical functions, minimise exposure to losses for taxpayers from their failure and improve legal certainty for their clearing members and clients. Almost all stakeholders agreed that, in order to safeguard financial stability, the continuity of key operations of CCPs should be the priority. Many considered that while it is critical to ensure that recovery and resolution arrangements for CCPs are credible and robust, these should not place excessive burdens on members or participants to cover potentially significant liabilities arising from the default of a major clearing member or, even less, from internal risk management errors by the CCP. Stakeholders generally noted that this necessitated tailoring the BRRD tools to the specificities of CCPs’ business models.
3.2.Collection and use of expertise
In addition to stakeholder-consultation, the Commission participated in the discussions and exchange of views informing the CPMI/IOSCO report providing guidance on the recovery of financial market infrastructures. The Commission also participated in the work relating to the resolution of other non-bank financial institutions carried out by the FSB, including the latest discussions on refining parts of this guidance to help authorities plan effective resolution strategies. On their part, in elaborating the reports proposing guidance on (respectively) recovery and resolution, both CPMI/IOSCO and FSB asked interested parties to provide comments on their draft guidance documents and published the responses received 13 . On the whole, these international level consultations for financial market infrastructures confirm the views expressed in the Commission’s own consultation, and provide useful additional feedback on the relative merits of some of the proposed policy options and resolution tools.
Commission services also held four meetings with Member States' experts to discuss the international work being carried out by the FSB and CPMI-IOSCO, the most contentious policy choices, and the scope and nature of the proposal. Member State experts generally agreed with the policy direction proposed by the Commission, based on the international guidance and building on EMIR and the BRRD as relevant.
3.3.Impact assessment
The Commission conducted an impact assessment of relevant policy alternatives. Policy options were assessed against the key objectives of safeguarding financial stability and confidence in CCPs, minimising losses for society as a whole and in particular for taxpayers and strengthening the Single Market for services provided by CCPs, while maintaining a level playing field.
The Impact Assessment (IA) was approved by the Impact Assessment Board (IAB) on 6 May 2015. The IAB made a number of recommendations for improvements. Taking into account these recommendations, the IA was further refined. In particular, the justification on the need for action at EU level and the identification and the assessment of the options were further substantiated. The options assessed and the conclusions reached were also checked against the latest guidance from the ongoing international work, which the Commission followed closely. The legislative proposal is fully in line with the latest FSB and G20 policy discussions and orientation 14 .
Regarding the need for action at EU level, the IA concluded that EU action is necessary given the cross-border nature of CCPs' business, which links multiple financial actors, counterparties and clients throughout the Single Market. The tools currently available to Member State authorities are inadequate to deal with CCPs that face significant stress which could compromise their viability. Divergent approaches across Member States to mitigate or tackle potential severe problems of CCPs could ultimately lead to the disruption of critical functions for the economy and wider financial instability. Acting at EU level is necessary to adequately equip Member State authorities with tools and powers that would have enforceability across the Union, to deal with the failure of CCPs located within their jurisdictions, and to ensure effective communication amongst all relevant authorities, whether in the same or in different Member States.
Appropriate recovery and resolution planning should help ensure that costs are not borne by taxpayers but rather by the market participants associated with the CCP (creditors, clearing members, their clients) in a proportionate and non-discriminatory manner.
Regarding the question of how resolution of CCPs can be ensured in a timely and robust manner, the IA examined options relating to possible triggers as to when to enter into resolution and options relating to which resolution tools and powers authorities should be equipped with.
The IA found that prescriptive triggers for resolution, such as the breach of specific requirements, would bring transparency to the resolution framework by making clear ex-ante to all stakeholders when a possible public intervention might be prompted. Prescriptive triggers would nevertheless not be suitable as it would be difficult to identify single or compound indicators that can clearly predict future events compromising financial stability. Prescriptive triggers could also leave undue room for entities to 'game the system', i.e. take measures around the triggers that would compromise the trigger's validity; moreover, CCPs could fail in a way that may not meet specific prescriptive conditions, and therefore resolution would not be available as an option to achieve an orderly restructuring or wind down. More flexible triggers that leave the decision on entry into resolution to authorities avoid these problems and provide authorities with the power to take quick and decisive action to resolve any systemically important CCP that is failing or likely to fail before it has become insolvent. The IA concluded that more flexible triggers are the preferred option; however, it highlighted that it is essential to ensure that authorities will only use resolution tools if a CCP is close to failure and no other measures can restore its viability and ensure overall financial stability, and most importantly that it would be in the public interest to place the CCP into resolution, rather than subjecting it to normal winding up or insolvency proceedings.
As regards resolution tools and powers, the IA concluded that resolution authorities should be equipped with a harmonised but not exhaustive and not prescriptive resolution toolkit that affords authorities the necessary discretion to take into account the circumstances of a potential crisis. Conceivable paths of how to potentially resolve an entity in various scenarios would be laid out in non-binding resolution plans. The alternative option of equipping authorities with a comprehensive, exhaustive toolkit and setting out the order in which the tools should be used was rejected as it could risk the effectiveness of resolution by limiting authorities' ability to respond in a flexible way to the specific circumstances of an evolving crisis situation. It was considered unlikely that perfectly matched resolution tools and a hierarchy of their use could be developed to address all conceivable crisis scenarios, which would risk that envisaged resolution measures would not be appropriate to deal with the concrete problems at stake.
With regard to specific tools, the IA found that making the tools set out under the international guidelines comprehensively available in both recovery and resolution would minimise any costs borne by the taxpayer and would best achieve ex-ante market discipline. They would also enable distributing losses to all CCP stakeholders in a manner that provides certainty to market participants in advance and is as equitable as possible.
Market participants could be impacted differently by the various options, but a key aim of resolution is that they are no worse off than if the CCP had not been resolved but they would instead have been subject to further possible actions under the CCP's operating rules for allocating losses or if the CCP had entered insolvency.
Some other tools, such as requesting CCPs and clearing members to build up additional pre-funded means to absorb losses and replenish resources, were not considered to improve market discipline effectively or were deemed to be disproportionately costly in view of the low likelihood of being used. Overall, the preferred options were thus considered to contribute positively to maintaining financial stability and confidence in the broader financial system, without imposing undue or excessive costs which could weigh heavily on broader economic growth.
3.4.Fundamental rights
Like the BRRD before it, the framework for CCPs is fully compatible with the Charter of Fundamental Rights. While resolution action may entail changes to the assets and rights of CCPs’ owners and clearing participants, in accordance with Article 52 of the Charter, limitations on some rights and freedoms are allowed. As required by the Charter, such limitations on the exercise of these rights and freedoms are provided for by the Regulation, they respect the essence of these rights and freedoms, and they are only applied where genuinely necessary to meet the objectives of general interest recognised by the Union. The protection of financial stability has been recognised by the Court of Justice as a general interest, justifying restrictions to fundamental rights and freedoms under the Treaty provided that they are proportionate and suitable to reach the objectives they pursue. Affected stakeholders can also appeal specific elements of resolution decisions which impact them and are entitled to compensation in case they are left worse off than they would have been if the CCP had not been resolved but they would have been subject to further possible actions under the CCP's operating rules for allocating losses or the CCP had entered insolvency.
3.5.BUDGETARY IMPLICATION
The above policy options will have no implications for the budget of the Union.
The present proposal would require ESMA to (i) develop 5 technical standards and 2 guidelines, and (ii) take part in resolution colleges (together with EBA), make decisions in case of disagreement and exercise binding mediation. The delivery of technical standards is due 12 months after the entry into force of the Regulation. The proposed tasks for ESMA will not require the establishment of additional posts and can be carried out with existing resources, in most cases based on work already done by EBA in the context of BRRD implementation. The tasks for ESMA would also be prepared by a newly established ESMA resolution committee where relevant EBA competent authorities shall be invited to participate as observers, maximising use of existing resources.
4. OTHER ELEMENTS
4.1.Implementation plans and monitoring, evaluation and reporting arrangements
After entry into force, the preparation and development of proportionate recovery and resolution plans and the measures implemented by CCPs and authorities based on these plans is a tangible medium-term indicator for follow-up. In the event of distress affecting a CCP, other indicators to monitor would be whether, when and how CCPs are activating their recovery plans and whether, when and how supervisory authorities are taking action in accordance with the early intervention powers granted by the framework. Finally, in the event of CCP-failure and of the resolution conditions being met, the indicators to monitor would be when resolution authorities intervene, which tools they use, and how any losses are shared among private stakeholders. An examination of the functioning of specific provisions as well as a more general review could be carried out after three years. The monitoring and evaluation frameword could be refined in this context as appropriate, building on concrete experience with the regime.
4.2.Detailed explanation of the specific provisions of the proposal
Contents
- 4.2.1.Scope and objectives
- 4.2.2.Set-up of resolution authorities and resolution colleges
- 4.2.5.Early intervention
- 4.2.6.Resolution triggers
- 4.2.7.Resolution tools and powers
- 4.2.8.Ancillary provisions concerning resolution
- 4.2.9.Third countries
- 4.2.10.Changes to the Company Law Directives, BRRD, EMIR and the ESMA Regulation and creation of an ESMA Resolution Committee
In view of their function and central role in financial markets, the scope covers all CCPs established in the EU. The relevant powers and tools bestowed by the Regulation would thus be available for use in relation to all CCPs irrespective of their size, interconnectedness or other characteristics. Proportionality would nonetheless be assured as recovery and resolution plans are to be specific to each CCP and take due account of their systemic relevance. The exercise of the early intervention and resolution powers by authorities should, in all cases, also be proportionate and justified.
The objectives are, first, to seek the orderly recovery of CCPs in various scenarios of financial distress through the implementation of robust and comprehensive recovery plans, agreed between the CCP and its clearing members. Second, if this were to be insufficient and the conditions for resolution were to be met, authorities should take swift action in order to safeguard financial stability, secure the continuity of the CCP’s critical functions, and protect taxpayers to the maximum extent. In case of resolution, action by the authority should be predicated on the owners, creditors and counterparties of CCPs bearing losses in line with the hierarchy of claims in insolvency, and managers being replaced and held accountable for any wrong-doing under national law.
Due to their legal and corporate structure, effective CCP recovery and resolution does not necessarily need to encompass the wider groups of which CCPs may form part. However, where expedient to achieve the objectives above, specific powers can apply to the parent companies of CCPs. These include for instance the option for authorities to decide on a case-by-case basis that recovery plans should cover parent companies.
Resolution authorities for CCPs shall be set up and equipped with a harmonised set of powers to undertake all the relevant preparatory and resolution actions below. The authorities can be central banks, competent ministries, the competent authorities (i.e. supervisors) of CCPs or other public administrative authorities. In case the powers are assigned to an existing authority, appropriate operational independence should be in place for the resolution functions. In case of multiple authorities possessing these powers, tasks should be clearly allocated. The appointed body(ies) are to have statutory tasks in order to ensure the orderly resolution of CCPs where the conditions for resolution are met, in a way which protects financial stability and taxpayers. It is not excluded that the authority can have similar duties in relation to other financial institutions. Where required under national law in a Member State, courts can be involved in approving the decision to resolve a CCP, provided that the procedure is expeditious.
Considering the role and precedent set by EMIR for colleges and for their tasks, as well as the possible impacts which resolution actions can have on clearing members and other stakeholders, CCPs’ resolution authorities are required to set up and chair resolution colleges for each CCP. These largely mirror the composition of the colleges in EMIR. In addition to the CCP’s resolution authority, members of the college should therefore include the competent authorities of the clearing members, CCPs, central securities depositories and trading venues present in the EMIR college, as well as the relevant central banks, and ESMA. In addition, other members should include, the resolution authorities of the clearing members whose competent authorities are members, if different, the relevant competent authority of any parent undertaking to which recovery plans would apply, as well as any competent ministries afforded a specific role in the resolution of CCPs, and EBA. The existing colleges under EMIR and the newly set-up resolution colleges should jointly undertake the specific tasks allocated to them under this Regulation, as described below.
4.2.3.Preparation – recovery plans
CCPs are required to prepare recovery plans to overcome any form of financial distress which would exceed their default management resources and other requirements under EMIR. This should include scenarios involving defaults by clearing members (i.e. default events) as well as the materialisation of other risks and losses (i.e. other (non-default) events). The precise circumstances in which the plans should be triggered would not be fixed in the law but CCPs are required to develop suitable indicators informing clearing participants and authorities for when this would occur. The plans should not rely on any extraordinary public financial assistance but should outline how possible access to central bank facilities under standard terms could be obtained.
In line with the CPMI-IOSCO guidance, the plans should be comprehensive, effective, transparent and measurable for those potentially impacted by them, set appropriate incentives and minimise negative impacts for all stakeholders and the financial system more broadly. Subject to these principles, CCPs can determine the appropriate range of options and recovery tools. These include tools to re-match the CCP’s book through tearing up contracts, such that the contracts are terminated and the losses and gains are crystallised, establishing voluntary agreements such as auctions with the remaining clearing members such that they voluntarily take on positions, or to arrange for additional resources by requiring clearing members to provide additional resources subject to a cap ("cash calls") and haircutting payments due to clearing participants as a result of an economic gain in a derivatives contract (“variation margin haircutting”). The Regulation neither determines which specific options recovery plans should contain nor excludes others. However, it requires that the plans should constitute arrangements agreed between CCPs and their clearing members in order to reinforce their effectiveness in all cases, binding or committing clearing members to act in accordance with the pre-agreed operating rules in case they are activated regardless of the jurisdiction in which they are based. Clearing members are required to fully inform their clients how they would transmit any losses or costs arising from the exercise of recovery tools by the CCP to them.
Recovery plans are to be reviewed by the competent authority of the CCP. Considering the possible impacts of the plan on clearing members and other stakeholders, the college set up under EMIR should be associated in the process. For instance, the assessment of the plan’s adequacy should be subject to a joint decision by the college. In case a joint decision cannot be reached, binding mediation could be carried out by the European Securities and Markets Authority (ESMA), in line with its mandate (Article 19(3) of Regulation (EU) No 1095/2010).
4.2.4.Preparation – resolution plans and resolvability assessments
Resolution authorities are required to prepare resolution plans for how CCPs would be restructured and their critical functions kept alive in the event of their failure. As in the case of recovery plans, they should cover both default events and other (non-default) event scenarios, and should not assume any extraordinary public financial support besides access to central bank facilities under standard terms. The plans should outline the resolution powers and tools which authorities would employ in case a CCP meets the conditions for resolution, proportionate to and in full consideration of the business model, market share and systemic relevance of the CCP both in the jurisdiction in which it is established as well as in other Member States and third countries. The plan is not binding, but any departure from it at the point of resolution should be duly justified by the authority.
As part of resolution planning, resolution authorities should also assess the overall resolvability of the CCP and address any impediments thereto. Consequently, they should have powers requiring the CCP to, for example, change specific business practices or its operational or legal structures, revise any intra-group agreements which could hamper resolution, or increase its pre-funded loss-absorbing resources on a case-by-case basis.
As in the case of recovery plans, the possible impacts of actions on clearing members and stakeholders means that resolution colleges should be associated in drawing up the resolution plan and in agreeing to any measures to address resolvability. For instance, the resolution college should be required to reach a joint decision in both cases, failing which binding mediation by ESMA could be carried out.
Competent authorities are granted specific powers to intervene in the operations of CCPs where their viability is at risk but before they reach the point of failure or where their actions may be detrimental for overall financial stability. The powers would complement those in EMIR, constituting specific supervisory options in these circumstances. Notably competent authorities could require the CCP to undertake specific actions in its recovery plan, or to refrain from taking such action.
A CCP should be placed in resolution when it is failing or likely to fail, when no private sector alternative can avert failure, and when its failure would jeopardise the public interest and financial stability. In addition, in line with the guidance of the Financial Stability Board Key Attributes for Effective Resolution Regimes, a CCP could be placed into resolution even if not all of these conditions are met, where the application of further recovery measures by the CCP could prevent its failure but could compromise financial stability in the process. Except for very specific circumstances, the CCP should also be considered to be failing or likely to fail if it requires extraordinary public financial support.
The resolution authority would assess whether all conditions are met. The assessment of the first condition (whether the CCP is failing or likely to fail) should however be the primary responsibility of the competent authority. It is generally considered that competent authorities are more likely to have a detailed understanding of the CCP’s financial health up to the point of failure. However, provided they have all necessary data and information to do so that assessment can also be carried out by the resolution authority.
As resolution action would be set out in the resolution plan in advance, it should be carried out in a way which does not undermine the functioning of the rest of a wider group of which the CCP may form part. Any outstanding contractual obligations of financial support for the CCP, such as guarantees from a parent undertaking, should however be exercisable by the resolution authority, in line with how they would be called upon in normal insolvency proceedings.
Resolution should be undertaken by way of several tools which could be used separately or in conjunction: (i) sale of a CCP’s entire or critical functions to a viable competitor, (ii) creation of a publicly controlled bridge CCP, and (iii) allocation of losses and positions among clearing members. The Regulation does not mandate which tools and powers to use in different scenarios but leaves the choice to the authority, depending on the circumstances but where practicable in line with the resolution plan agreed by the resolution college.
The various loss and position allocation options would provide the resolution authority with means to re-match the CCP’s book, stem further losses and obtain additional resources to recapitalise the CCP. Depending on the options chosen by the CCP and approved by the EMIR college as part of recovery plans, there can be overlap in the loss and position allocation tools available to the CCP as part of its recovery plan and to the resolution authority during resolution. For instance, resolution could take the shape of further auctions of the defaulters’ positions among remaining clearing members, a partial or full tear-up of contracts, further haircuts of outgoing variation margin payments, the exercise of any outstanding cash calls set out in recovery plans or of a cash call reserved specifically for the resolution authority in the CCP's internal (operating) rules, and a write-down of capital and debt instruments issued by the CCP or other unsecured liabilities and a conversion of any debt instruments or other unsecured liabilities into shares.
Finally, the Regulation does not exclude the possibility for resolution authorities to exercise other options in accordance with the principles of resolution, including full respect for the hierarchy of claims, such to avoid public bail-outs and moral hazard etc., notwithstanding the safeguard that no creditor should be left worse-off than in insolvency. As such they can call on further private resources, either within the CCP (e.g. using default funds of non-affected product lines) or from outside parties (e.g. calling on clearing members to voluntarily accept further allocations of positions). Should these options be unavailable or be demonstrably insufficient to safeguard financial stability, government participation in the shape of equity support or temporary public ownership could be considered as a last resort. Such steps by the government would nonetheless need to comply with applicable rules on State aid, including a restructuring of the operations of the CCP, and enable the deployed funds to be recouped from the CCP over time.
Separately, temporary liquidity support from the central bank could, while not a resolution tool, facilitate the process of resolution. Such support would be subject to the scenarios set out in resolution plans under which CCPs in resolution could be envisaged to access central bank liquidity, and to the ultimate discretion of central banks themselves.
In order to ensure that resolution decisions are taken in accordance with key principles regarding property rights, compliance with relevant securities and company law and national constitutional arrangements, the Regulation includes the necessary provisions and steps which resolution authorities would have to comply with before and upon taking resolution decisions. For example, these include ensuring an accurate valuation of the balance sheet of the CCP, safeguards for affected stakeholders to receive compensation if they end up worse than if the CCP had not been resolved but they would have been subject to further possible actions under the CCP's internal rules for allocating losses or in insolvency and the procedural steps by way of which authorities should notify the CCP and other authorities concerned of resolution decisions.
To facilitate resolution and the objective of safeguarding financial stability, the framework also includes a temporary moratorium on certain obligations of the CCP and stays on the ordinary rights of counterparties to terminate and close-out against the CCP arising solely by virtue of the exercise of resolution powers in relation to the CCP. Accompanying these steps are appropriate protections for payments due to other financial market infrastructures and for collateral and netting arrangements in line with those in the BRRD.
The distress or failure of a CCP can have international spill-over-effects, in particular where its clearing members are established in jurisdictions other than where the CCP is established. The FSB Key Attributes set out that authorities in different jurisdictions should cooperate in resolution cases, to recognise and enforce each other’s resolution actions in relation to relevant actors, assets or liabilities located in their territory.
In order to improve the enforceability of an EU authority’s action on clearing members located in third countries, CCPs would be required to ensure that the actions in their recovery plans are binding across jurisdictions. This means ensuring that recovery options constitute contractual obligations under the law of the country in which the CCP is established, or otherwise demonstrating to the satisfaction of competent and resolution authorities that the plans’ provisions are enforceable, for instance under the law of a third country. This would help resolution authorities enforce any outstanding obligations in these plans in resolution.
Beyond this, authorities should engage in cooperation with a third country authority in order to recognise and enforce its decision in relation to any relevant assets or contracts governed by the law of that country. Resolution authorities should enter into cooperation arrangements with authorities in third countries setting out the details of cooperation. For any given CCP, there may be several Member States or third countries where clearing members could be located or under whose laws relevant assets or contracts could be governed. ESMA should therefore issue guidance on the relevant content of those arrangements with concerned third countries, in order to establish common application of the conditions in these cases.
In order to facilitate the enforcement of actions by a third-country resolution authority on relevant clearing members, contracts or other assets or liabilities located in the EU, relevant national authorities should be in charge of recognising and giving effect to them, or refusing to do so in specific circumstances. Recognition should occur provided the measures do not have an adverse effect on the financial stability of the Member State, creditors of the CCP receive the same treatment as other creditors regardless of location, and there would be no material fiscal implications for the Member State.
4.2.10.Changes to the Company Law Directives, BRRD, EMIR and the ESMA Regulation and creation of an ESMA Resolution Committee
The Union Company Law Directives contain rules for the protection of shareholders and creditors. Some of these rules may hinder rapid action by resolution authorities. These rules have already been amended as regards banks by Directive 2014/59/EU and, pursuant to the Commission proposal amending Directive 2014/59/EU (COM(2016) 852), the application of those amendments is proposed to be extended in national law to CCPs 15 .
Pursuant to the Commission proposal amending Directive 2014/59/EU (COM(2016) 852), CCPs with banking licences subject to the BRRD will be, by the time this Regulation is applicable, carved out of scope of that Directive and brought exclusively under the arrangements and requirements of this Regulation.
Furthermore, in order to ensure that authorities can impose penalties when the provisions of the proposed Regulation have not been complied with, the Commission proposal amending Directive 2014/59/EU (COM(2016) 852) stipulates extending the scope of application of its Title VIII also to CCPs. This extension ensures that sanctioning powers regarding recovery and resolution of financial institutions are consistent.
EMIR is amended to introduce the possibility for a clearing obligation to be temporarily suspended in the context of resolution of a CCP where necessary to preserve financial stability and market confidence, in particular to avoid contagion effects and to prevent counterparties and investors having high and uncertain risk exposures to a CCP. The role of CCPs' risk committee is also enhanced to encourage the CCP to manage its risks prudently.
In order to ensure that the authorities responsible for resolution may provide input to the work of ESMA under this Regulation, they should be able to accompany the competent authority to meetings of the ESMA Board of Supervisors who shall be non-voting. To prepare its decisions under this Regulation and ensure full input of EBA members in this process, ESMA is required to set up a committee for this purpose where certain competent authorities under Regulation 1093/2010 shall be invited to participate as observers.