| LONDON, July 31
LONDON, July 31 Clearing houses must plan for an
orderly rescue and even their own demise to prevent their
growing importance in the financial system from becoming a
source of market disruption when things go wrong, global
regulators said on Tuesday.
The clearers, which stand behind trillions of dollars of
derivatives contracts, have become an important part of reforms
to the financial services industry after the collapse of U.S.
bank Lehman Brothers and near failure of insurer AIG.
It took so long to untangle the derivatives contracts held
by these two companies during the crisis that world leaders
agreed in 2009 that much of the $650 trillion over-the-counter
(OTC) derivatives traded among banks must pass through clearing
houses from the end of this year.
The clearing houses, such as the Depository Trust & Clearing
Corp (DTCC), LCH.Clearnet and Eurex Clearing, keep
electronic records and are backed by a default fund used when
one side of a trade goes bust. But the increase in the volume of
contracts they will have to handle could make them "too big to
fail" in a crisis, leaving taxpayers footing the bill to rescue
To try to tackle this problem regulators set out on Tuesday
how the clearing houses must prepare "death plans" or "living
wills" for an orderly rescue or demise.
"The vital role of the financial system's infrastructure
makes it essential that credible recovery plans and resolution
regimes exist," said Paul Tucker, deputy governor of the Bank of
England and chairman of a global central bankers' committee on
payment and settlement systems (CPSS).
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Written jointly with global markets supervisory body IOSCO,
the proposals include tearing up unmatched derivatives contracts
held by a failed clearing house whose default fund has run dry.
The contract would be valued and closed out, with any profit
or loss handed back.
The proposals make it clear that regulators are looking for
ways to share out losses from a bust clearing house on the
But there is already criticism from the industry.
"For a while the idea of tear-ups were considered to be a
helpful way forward, you would have certainty, but the mood is
changing in some quarters of the market and there is a live
debate right now," said Damian Carolan, a partner law firm at
Allen & Overy.
"The disruption it would cause to be cut adrift and having
to build up new positions from scratch in the OTC
(over-the-counter) space is hard to imagine," Carolan said.
He recommended an array of tools, such as voluntary
recapitalisation of a clearing house's default fund from
contributions from its members, rather than pre-set actions that
could be inflexible.
Clearers will have to hold far more capital in future,
enough to withstand the collapse of their two biggest clients.
But critics argue the largest clearing houses in the sector will
always be too big to fail.
The proposals on what to include in living wills are out for
public consultation until September and the feedback will be
used to help supervisors check that clearers have properly