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EU plans clearing house protection by other financial institutions

The European Commission is putting together plans to protect the financial market if a clearing house collapses, including using funds from other financial bodies, the Financial Times has reported. 05 Oct 2016

Clearing houses act as 'central counterparties' between buyers and sellers to a particular trade, meaning that neither party to the trade itself is exposed to the risk of the other defaulting.

As a result of new rules implemented in response to the financial crisis of 2008 more than 70% of global swap transactions now take place through a third party rather than being traded directly.

Under the Brussels proposal, clearing house members such as banks would be expected to prop up a clearing house that got into difficulty. The participants would be given a share in the clearing house in return, according to documents seen by the Financial Times.

EU authorities would also be able to reduce payments to clearing house members, and regulators would be allowed to use government money to prop up the clearing house in a systemic crisis, so long as this was within state aid rules, the Financial Times said.

Trade bodies The Clearing House and the International Swaps and Derivatives Association warned in May that clearing houses could become 'too big too fail. The growth of mandatory clearing during derivatives trades has "significantly increased concentrations of risk" within the largest clearing houses, with the result that their failure could risk financial stability, they said.

Banking reform expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com said: "Obviously this process will be further complicated by whether we face a ‘soft’ or ‘hard’ Brexit, being closely aligned with EU regulation or a less certain ‘equivalence’ model, or something else. The level of ‘forced participation’ fundraising by clearing house members and the rights, if any, attached to the shares they would receive in return are the key questions, especially for banks, at the moment."

"This measure is being framed as a last resort option to save clearing houses since they became the latest ‘too big to fail’ institutions. The risk has simply been passed on with the introduction of mandatory central clearing," Anderson said.