LONDON All clearing houses for securities trading in the European Union will be required to comply with new rules aimed at managing their financial collapse in a way which does not jeopardise the smooth working of markets, a draft EU law seen by Reuters showed on Tuesday.
Clearing houses or central counterparties (CCPs) stand between two sides of a transaction, ensuring its completion even if one side goes bust. Their usage is set to expand sharply in the coming years as regulators make central clearing compulsory for over-the-counter trades in financial derivatives such as interest rate swaps.
The draft EU law sets out how regulators should deal with a failing or collapsed clearing house in a way that shields taxpayers without disrupting markets.
It is in the form of a regulation, meaning it will be directly binding on the bloc's member states, leaving little wiggle room for local regulators. This differs from a similar EU law for handling failing banks which gave countries more leeway.
"Considering their central and growing role in financial markets, all CCPs in the EU are therefore considered to be systemic," the draft law said.
"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."
Costs of and losses from a failing clearing house "are imposed as far as possible on the CCP's owners and creditors, not the taxpayer," the draft says.
"Resolution does not aim to prevent the failure of inefficent 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."
All clearing houses will have to draw up plans showing how they would recover from a major financial shock. Regulators would be in charge of deciding when to intervene to resolve or close down or restructure the entity, the draft law said.
Managers would be replaced and held accountable for any wrongdoing under national law, it said
A body should be set up in each country to deal with any collapses, but existing bodies who deal with collapsed banks could also fulfil this task, the draft law says. This would, for example, allow the euro zone's resolution body for bank failures, the Single Resolution Board, to add clearing houses to its remit.
Regulators should intervene before the point of failure is reached or when financial stability is threatened, the draft law says.
Anticipation of the draft law triggered a big debate in the industry over who should pay for a failure once the default funds have been exhausted. Users such as mutual funds have resisted being included in a whip round at his stage but the draft law does not rule out any action.
"The regulation neither determines which specific options recovery plans contain nor excludes others ... 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."
(Reporting by Huw Jones; Editing by Greg Mahlich)