Thursday, January 7, 2010

LSE chief urges safeguards on clearing houses

Original posted in the Financial Times by Jeremy Grant:

Clearing houses in Europe should be regulated by central banks to guard against the risk of a catastrophic failure by one of them, the London Stock Exchange‘s chief executive said.

Xavier Rolet, a former Lehman Brothers and Goldman Sachs banker, said that it was “very dangerous” for clearing houses’ capital bases and risk models to differ from country to country.

His comments come amid growing concerns that the insistence by policymakers that more financial instruments – such as over-the-counter derivatives – should be processed through clearing houses could overwhelm a clearer and spark a new crisis.

A clearing house stands between buyer and seller in a trade, using funds – or margin – deposited by its members to guarantee deals are completed even in the event of a default.

Efforts are under way on both sides of the Atlantic to force more OTC derivatives through clearing houses to guard against the ripple effects of a default such as the collapse of Lehman.

The Financial Services Authority, which regulates clearing houses in the UK, said last week: “The drive to have a significantly greater proportion of OTC derivatives markets centrally cleared will further increase the systemic importance of [clearing houses].”

Mr Rolet said it was possible that a clearing house could be overwhelmed if in the case of a default the clearing house members were unable to cover the margin calls that the clearer would make to cover the losses.

Margin is the funding posted by market participants that are members of a clearer as a form of insurance against default.

He said that clearing houses should have access to the funding provided by central banks through their discount window in the case of an emergency.

“This is not about fear-mongering, but where a clearing house has a substantial amount of ‘binary risk’ products that require a potentially huge collateral [margin] call which the [members of the clearing house] are not able to supply then the question is: who funds it?” said Mr Rolet.

“It seems sensible to us that the central banks should have at least a funding relationship to clearing houses.”

He said Europe needed a “harmonised, integrated clearing industry with standardised regulation” and “lending arrangements” with central banks.

In the US, the Federal Reserve does not regulate clearing houses.

But the Obama administration has proposed giving the Fed oversight of “systemically important clearing houses”.

Mr Rolet’s comments come as the European Commission is to address the issue of clearing in a directive early next year.

This is expected for the first time to define what a clearing house is, establish rules under which clearers should be managed and possibly stipulate what capital requirements should apply.

A draft of the directive is expected to be finalised this week.

Asked if Brussels should also address the issue of regulation by central banks, Mr Rolet said: “I think it certainly would be good if it did.”

No comments: