On 23 December 2012, ISDA published a letter sent in response to the EU Commission’s Consultation on a possible recovery and resolution framework for financial institutions other than banks.
ISDA’s response focuses mainly on RRP for Central Clearing Counterparties (CCPs). It believes that a common resolution framework should apply to all FMIs (and not just to those which exceed specific thresholds in terms of size, level of interconnectedness etc.). To the extent that an FMI is also a credit institution, ISDA believes that this framework should apply above and beyond the RRP requirements applicable to banks.
ISDA agrees that the general objective for the resolution of FMIs should be continuity of critical services and that any RRP framework should emphasis the issues of recovery and continuity over that of resolution. More specifically, ISDA emphasises that any RRP initiative should be consistent with seven key principles as set out below.
1. CCP loss allocation procedures must be certain, transparent and avoid unlimited liability for Clearing Members
ISDA asserts that limited liability for clearing members will promote financial stability as it will reduce incentives to “rush for the exits” during a period of stress. Loss allocation procedures which are not consistent with this principle, such as forced tear-ups and uncapped default fund liability should be avoided. In addition, ISDA believes that it is unrealistic to think that indirect participants and clients of clearing members can be shielded from losses, although it believes that the specifics of this aspect are best dealt with as a matter of direct agreement between counterparties and to relevant conduct-of-business regulations.
2. CCP loss allocation rules should be respected and applied prior to implementation of resolution
ISDA believes that resolution should only be triggered after an FMI’s agreed and documented recovery arrangements have been given the opportunity to succeed an only after consultation (however brief) with market participants.
3. Any framework must be consistent with CPSS-IOSCO FMI RRP principles
ISDA believes that the ultimate success of any RRP initiative is dependent on the creation of a globally consistent standard.
4. The relationship between recovery and resolution of CCPs must be clear, predictable and transparent
Resolution should only occur when it is where it is ‘necessary’ (rather than merely ‘desirable’) to address a serious threat to financial stability. This arises when an FMI has reached the point where there are no realistic prospects of recovery over an appropriate timeframe, when all other intervention measures have been exhausted, where additional losses arise from a source for which there are no CCP rules, and when winding up the institution under normal insolvency proceedings would risk causing financial instability.
In the interests of predictability, there should be no ability for authorities to intervene before an FMI meets the conditions for resolution. Rather pre-resolution actions of a supervisor should be limited to providing guidance and ensuring the effective implementation of the FMI’s own procedures.
5 Robust procedures for the transfer of membership agreements and positions must exist
Procedures regarding the porting of positions to a solvent FMI must be established before the event and tested periodically. In addition, any transfer must be done in a way that does not interfere with members’ existing rights to net exposures against a CCP. More specifically, ISDA believes that the power to impose a temporary stay on the exercise of early termination rights is not necessary in the context of a failing FMI. Moreover, it regards the ability to enforce a moratorium on payments beyond a “very limited grace period” as a potentially “dangerous” tool, which should only be available on an exceptional basis when a CCP has non-cash collateral which it is unable to convert into cash as quickly as necessary. However, as a last resort only, ISDA regards it as “entirely appropriate” for CCPs to include within their recovery provisions the possibility of terminating a particular product set if this is necessary in order to restart a particular market or avoid the effects of contagion.
6 Co-operation and co-ordination between authorities is essential
ISDA agrees that strong cross-border cooperation and coordination, both before and during resolution, are essential to the successful resolution of a failed FMI, with the failing FMI’s national resolution authority taking the lead coordinating role. Fundamentally, however, it believes that the CPSS, IOSCO and FSB should move beyond existing international RRP standards and adopt a substantive international convention on the resolution of cross-border financial institutions, such as was recommended by the International Institute of Finance in its June 2012 paper entitled “Making Resolution Robust – Completing the Legal and Institutional Frameworks for Effective Cross-border Resolution of Financial Institutions”.
7 Safeguards: Netting and collateral arrangements must be protected throughout resolution
ISDA believes that intervention powers cannot be unfettered or apply retrospectively. Rather, they should contain restrictions on the transfer of part only of a CCP’s business in a way that interferes with members’ netting rights. In addition, it is essential that the hierarchy of claims in insolvency be respected and that creditors should not be worse off than in insolvency.