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Regulators Continue to Force Additional Liquidity Burdens on CCPs

Bank of England governor, Mark Carney, has reportedly said that clearinghouses must have enough liquidity available to cope with the default of two of its big member firms.

Should a clearing member fail CCPs will be expected to cover for this loss using the reserve funds that it holds, previously submitted by its members. Should this reserve prove insufficient it can then suck in additional funds from its members in what it known as a waterfall arrangement.

"It is extremely important that CCPs organise themselves to make sure they can provide the necessary resilience plan through the waterfall arrangements that are in place – and through their own liquidity insurances – to the extent they can cover the failure of one or two major institutions," Carney is quoted as saying at BoE press conference.

The CCPs need to have this additional liquidity in place as the UK central bank will only provide liquidity support to these venues as a last resort, according to the BoE.

Liquidity at the CCP has also been a hot topic in the US recently after the CFTC announced last month that it will not treat US Treasury securities as “qualifying” liquid resources for CCPs. Instead, the Commission now requires that CCPs obtain “prearranged and highly reliable funding.”

This will prove to be more expensive for CCPs because it means that it must get a committed line of credit from banks who, under the new Basel III rules, will face capital charges for issuing the line of credit. These charges will inevitably be passed onto the CCP.

Commenting on the recent rules issues by the CFTC in his Streetwise Professor blog Craig Pirrong, professor of finance and energy markets director of the Global Energy Management Institute at the Bauer College of Business, University of Houston, argues that they will have a negative impact on the markets.

He claims this “it is highly unlikely that bank lines are a better source of liquidity, especially under crisis situations, than Treasuries. Indeed, they are plausibly worse, and actually create an interconnection that can transmit a shock to the derivatives market (and the CCP that clears it) to systemically important banks: this is the exact opposite of what clearing was supposed to achieve.

“The cost of the lines, which is likely to be substantial, particularly given their necessary size, is a deadweight burden on the markets: all pain, no gain.”

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