CCP Recovery and Resolution: How to avoid pro-cyclicality and increased systemic risk in distressed markets
The failure of Lehman Brothers almost a decade ago showed the shock-absorbing capacity of CCPs. However, what is missing today from the CPP legislation is a recovery and resolution framework. Two elements are critical for the credibility of this framework:
i) the distribution of the losses from the resolved CCP (e.g. cash calls and variation margin gains haircuts), and
ii) the coordination of the resolution activities (e.g. disclosure of the resolution plans).
Regarding resolution colleges, even though their role is vital in coordinating the preparation and execution of the CCP resolutions, there is a broad consensus that it will be very challenging to make them work effectively. Supervisory colleges are already large, but resolution colleges are even larger (involving ministers, competent authorities, resolution authorities, etc.). Experience with the banking crisis has shown that such a group should be small and flexible. Given the lack of experience with CCP resolution using colleges and their complexity, it will be essential to regularly conduct simulations on all the potential crisis scenarios. A switch from the currently foreseen rule-based approach to a more principle-based approach, could also be helpful.