At the recent G20 summit earlier in September, China – the current head of the G20 – put further strengthening the resilience of central clearing parties high on the agenda: these globally important firms clear the large part of the financial sector's derivative contracts. The move in recent years to require ever more clearing to go through central counterparties (CCPs) is good for transparency and should go a long way to reducing risk. But if more reliance is being concentrated in CCPs, it is vital to have a robust system in place to resolve them if things go wrong.

Effective resolution regimes

When G20 leaders met in 2009, they committed to a series of reforms to tackle the root causes of the financial crisis and transform the system for global financial regulation. In particular, they called for effective resolution regimes for systemically important financial institutions, to try and protect the economy from the threat of major banks and other big financial institutions going bust in a way that would destabilise the financial system and impose undue costs on taxpayers. The obvious starting point was banks, which are used by all and whose weaknesses have been highlighted in the aftermath of the 2008 financial crisis. Developing global rules to tackle this "too-big-to-fail" problem has been a major success of the G20.

At the same time, the G20 took steps to address the problem of contagion, or the negative repercussions of the distress of one or several financial intermediaries on others. In order to prevent contagion in over-the-counter (OTC) derivatives markets they required 'central clearing' of these products. This means that when two firms trade derivatives, they must have a central counterparty placed between them, acting as a buffer in case one side defaults and limiting damage to the financial system. As a result, in 2015, on average more than 50% of the $ 493 trillion global market in OTC derivatives was centrally cleared by CCPs across all types of derivative contracts. This almost doubles the percentage from the G20 commitment in 2009. On average, 70% of all new transactions could now potentially be cleared based on the current CCP offering.

There is widespread agreement among G20 leaders that the overhaul shouldn't stop there. In this respect, a major milestone was reached under the Chinese G20 presidency with the near-completion of rules for the recovery and resolution of CCPs. Although there have been no recent systemic failures among CCPs, the inherent cross-border nature of their activities, their international reach, their interconnectedness with other global systemic financial institutions and their increased importance following the implementation of G20 derivatives reforms makes action necessary.

The business models of CCPs differ significantly from those of banks, reflected in the regulatory regime that applies to them in the EU (the 2012 European Market Infrastructure Regulation or 'EMIR'). They are less likely to get into distress or fail entirely. But the business volume of some CCPs is enormous and will increase even more with the start of mandatory clearing of standardised OTC derivatives. So the role played by CCPs as key bulwarks for global financial stability is set to grow. And – as many operate across the EU and beyond, with the largest global banks all directly linked to the world's principal CCPs – the risk of global contagion if something goes wrong also looks set to increase. Therefore, despite the stringent prudential rules of EMIR that make CCP failure unlikely, it is important to have an effective framework to intervene in case a CCP gets into distress.

Internationally consistent rules

In the ongoing work in the G20 to monitor and refine financial sector robustness, there is an increasing recognition that recovery and resolution rules aimed at mitigating the risks of CCP failure should be as internationally consistent as possible. The Financial Stability Board (FSB) and the Committee on Payment and Market Infrastructures and the International Organisation of Securities Commissions (CPMI-IOSCO) adopted global standards on these issues in October 2014. While these standards remain valid, they require further refinement. Thanks to the international cooperation in this area, CCPs in all global financial centres will be subject to comparable requirements to address any weaknesses. As the costs of the new rules should be proportionate, they will have to strike a balance between the need to foster central clearing, financial stability objectives and appropriate incentives for CCP users to support recovery efforts.

Authorities now also have a more consistent and shared understanding of how the resolution of CCPs could be carried out in an effective and non-discriminatory way. There is a general consensus that resolution authorities should be able to intervene before the CCP's own efforts to restore its viability are exhausted or begin to compromise overall financial stability.

The need for CCP resolution is likely to remain relatively rare. Thanks to the single market, EMIR and the Bank Recovery and Resolution Directive (BRRD), the EU already has a strong base for developing cross-border rules for CCP recovery and resolution. This international guidance is vital to complete the picture and ensure that even in resolution CCPs can continue to provide services that are essential to financial markets, in a way which spreads costs in a fair and transparent way and minimises spill-overs to the real economy.

During their last Summit, the G20 leaders stressed the importance of implementing an appropriate prudential framework capable of ensuring central counterparty resilience, recovery planning and resolvability. On the basis of the considerable work that has already been done, the Commission is set to propose an EU-framework on CCP recovery and resolution in late-2016. Once adopted, authorities will be able to develop the specific way they would use available powers and resources when intervening to cover all costs, safeguard the legitimate rights of CCP users, ensure market discipline and spare taxpayers from having to foot the bill.

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