Warsaw – The Network Forum Annual Meeting
Ladies and Gentlemen
It is a pleasure to be here in Warsaw today.
Clearing and Settlement used to be the boring part of market infrastructure
Seen as a cost centre by the front office
messy and complicated by financial supervisors
and dull and boring by politicians
The many references to the financial plumbing were not meant as a compliment
Quite frankly, most people simply wanted it to work
They didn’t care how
Following the financial crisis the importance of the post trade world became evident
the G20 heads of State - many of whom I’m quite certain would not previously have known what CCP stood for, let alone how clearing actually worked -
came together and put central clearing centre stage.
Suddenly the politicians cared about what happened in the post trade world
And once the focus has been placed on a sector, it is very hard to ever remove it.
I worked on the original EMIR legislation from within the European Parliament, and while industry has only been faced within it for a few years and the clearing obligation hasn’t even hit in for many market participants
We are already reviewing certain aspects of the regulation.
The Commission has released two legislative proposals concerning EMIR over the past few months.
The first is of interest to the people in this room - it is the nuts and bolts of EMIR
It focusses on fixing those issues that have been identified through two consultations with industry and supervisors and should round off the edges of EMIR
So, it simplifies the reporting for exchange traded derivatives and aligns it better with the MiFID reporting requirements, it removes the front loading and backloading provisions
It makes the non-financial exemption less burdensome to apply, and importantly for indirect clients and end users, it applies the FRAND concept to indirect clearing
assuring that this will have to be provided on a Fair Reasonable And Non-Discriminatory basis
These are all small tweaks to the framework that should improve its efficiency and I would encourage you to get involved with the process as the Council and Parliament start emending the Commission’s text
If they have not addressed an issue which you think would improve the functioning of the market then find the evidence and raise the issue
EU legislation typically gets reviewed 3 years after implementation so it is important to fully engage and explain to legislators the very real practical unforeseen consequences of policy decisions.
We are very open to fixing them.
The second piece of legislation released from the commission, is the one that the financial journalists love
The issue that sets politicians in France and the UK into a huge furore
Centralised European supervision of CCPs and new third country equivalence arrangements
I have to say, I was pretty surprised the day after the UK Brexit referendum when in the first statement from the then French President, Francois Hollande he referred to central clearing and the need to repatriate euro denominated clearing to the Eurozone.
To be honest, I was probably concerned with bigger things in that moment
Like trying to implement the largest and most abstract divorce settlement in global modern history
But the French President hit on your industry as the one to focus on.
Given what happened to him politically perhaps his successor will not follow his lead and focus on the real issues facing France instead, but this topic will roll on regardless.
The new proposal from the Commission does not go as far as the Banking Union.
It does not set up a new single supervisor for the 17 CCPs in the EU
It creates the concept of a CCP Executive Session within ESMA, staffed by 49 people who will work in cooperation with the national supervisors
They will jointly make the day-to-day supervisory decisions affecting the CCP.
I have to admit I am not entirely sure how this kind of joint decisions making will work
- particularly as one set of supervisors will be right here in Warsaw, and the other will be 1500 kilometres away in Paris
But that isn’t the biggest problem with the new set up
Above the complicated joint decision making process, is the central banks of issue of the currencies used within the EU.
These central banks are given an opinion over any decision made by the ESMA and the national supervisors, and unlike the complicated mediation mechanism that is set up for disagreements between them, there is no mediation for if the Central Bank disagrees with the supervisor.
If the Polish Central bank believes a supervisory decision made by Bafin and ESMA over Eurex effects their monetary policy, they put forwards amendments to that decision, and the decision can only be adopted if they are taken on board.
An effective veto.
Many people have commented since the financial crisis that Central Banks are now the controllers of our economy
Monetary policy now directs the fiscal and budgetary policy of many governments
Controversial and some would say unaccountable actions by the ECB in Greece have led to violent demonstrations
US senators have tabled amendments to abolish the Federal Reserve for the actions they have taken in increasing the money supply
Yet this latest proposal from the Commission reinforces and enshrines the primacy of Central bank’s monetary policy over financial stability
As a British politician I perhaps ought to take a step back and leave this for the “future EU 27” to debate
If they have decided that they no longer trust elected politicians and accountable institutions to manage financial stability then perhaps that should be up to them.
But the third country proposals suggested by the European Commission doesn’t just give this veto power to Central Banks from the EU over all decisions made in EU CCPs - but it suggests that they should have this power over all CCPs that have asked to be recognised by the European Commission globally.
This suggests that CME, a currently recognised CCP by the EU would have to allow decisions made over its collateral haircuts to be approved by any central bank of issue within the EU. So in that nightmare scenario where the US supervisor, the CFTC and the Fed have taken a decision, and even when ESMA and any EU national supervisor agree that it is the best decisions, theoretically, the Hungarian National Bank could require the exact opposite.
For someone like myself, who believes in global cooperation as the best way of coming together to resolve systemic risk issues, this type of power is not only dangerous to financial stability, it also puts pay to all of that global cooperation.
All the work done by the global Financial Stability Board, the CPMI-IOSCO and the long and involved bilateral discussions it took to get equivalence and substituted compliance agreed between the US and the EU.
Central clearing should not be a political football, used by one area to gain competitive advantage
It is a utility that needs be made as risk free and transparent as possible
For the past 5 years I have worked on looking at the recovery and resolution of CCPs
Looking at how you would deal with the Armageddon scenario of a globally systemically important CCP getting into trouble
Perhaps that’s why I am so focussed on maintaining the global cooperation elements of supervision - because the counterfactual of dealing with a CCP break down is simply so awful to imagine.
I hope the panel will now focus in more detail on the issue of recovery and resolution of CCPs, but just to give my thoughts in general
The most important thing to remember as we design the new recovery and resolution frameworks is that every tool and action in both a recovery and resolution plan should be examined for how it effects the incentives for each participant to ensure they are tied into the success of the CCP.
The fundamental reason why Central clearing works is because it is based on a model of risk mutualisation
Clearing members must know that the counter factual of not participating in default auctions will leave them in a worse situation.
CCPs must realise that if their margin models and investment policies or even their operational management are found to be substandard, they will pay the price.
The role of supervisory authorities in recovery planning for CCPs, beyond ensuring those incentives are properly aligned, must be to protect those who do not have a say over the operational management of CCPs; the clients of clearing members, indirect clients and ultimately, the tax payer.
For this reason the use of tools that affect these end users must be properly safeguarded so that clearing members and CCPs take full responsibility for losses that they might control through sound risk management.
Variation Margin Gains Haircutting and partial tear up of contracts must be subject to supervisory oversight and only used after cash calls from clearing members and contributions from the CCP itself.
A Resolution Authority needs to have the powers and flexibility to step in, not when clearing members or CCPs choose not to participate, but when they are genuinely unable to participate.
The use of actual resolution powers should be predicated upon the failure of EMIR, BRRD and the recovery measures outlined in this regulation. It is the most extreme of all scenarios, hence flexibility in the powers of Resolution Authorities is so important.
I look forwards to discussing these, and any other issues with the panel.