European Systemic Risk Board Publishes Report on CCP Interoperability Arrangements

The European Systemic Risk Board has published a report on interoperability arrangements between EU central counterparties. An "interoperability arrangement" is defined in the report as a link between CCPs that involves the cross-system execution of transactions. It is relevant where multiple CCPs service the same trading venue. The arrangements allow clearing members of one CCP to centrally clear trades carried out with members of another CCP, without requiring the first counterparty to be a member of the second CCP. A key motivation for such arrangements is the reduction of fragmentation in the open positions of trading participants and/or clearing members, as open positions in the same products can be consolidated at one CCP.

The EU system of CCPs currently has five such arrangements involving four EU CCPs (EuroCCP in the Netherlands, CC&G in Italy, LCH Ltd in the U.K. and LCH SA in France) and the Swiss SIX x-clear in Switzerland, together with its Norwegian branch. The links relate to the clearing of cash equities, government bonds and, in one case, exchange-traded derivatives. There are concerns that such links may represent a source of contagion between CCPs in the event of financial difficulty. Particular concerns are raised about interoperability arrangements for derivatives, on which the European Market Infrastructure Regulation does not contain clear provisions according to the ESRB.

The report describes interoperability arrangements in detail and considers the specific EU interoperability arrangements. It goes on to analyze the financial stability risks and benefits of CCP links. A key risk is the fact that interoperability arrangements obscure CCPs' view of some participants' trading positions, where those participants are not members of a given CCP. The report also considers the existing rules and regulations governing interoperability arrangements, which include Principle 20 of the Principles for Financial Market Infrastructures on CCP links and Articles 51 to 54 of EMIR on the approval process and risk management features of interoperability arrangements. CCPs that enter into interoperability arrangements are required to post margin to each other, but they are prohibited from contributing to one another's default funds to avoid direct contagion, meaning they do not participate in the default waterfall of the interoperable CCP. However, the European Securities and Markets Authority has also issued guidance stating that interoperability arrangements in relation to derivatives are permitted and are not subject to these provisions of EMIR, leading to a regulatory lacuna for these arrangements. Despite the substantial proposed changes to EMIR anticipated to come into force later this year under EMIR REFIT, there is currently no intention to make any changes to the regime for interoperability arrangements. The report goes on to consider the risks surrounding the recovery and resolution processes of interoperable CCPs, which it argues are not adequately covered by the upcoming CCP Recovery and Resolution Regulation. The final section of the ESRB's report describes areas of EU regulation that would benefit from further provisions on interoperability arrangements, including clarification on the treatment of interoperability arrangements in the upcoming CCP Recovery and Resolution Regulation and on whether interoperability arrangements for derivatives could be approved and under what conditions.

View the ESRB's report on CCP interoperability arrangements.

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