ESMA Final Report on CCP Interoperability Risks and Costs

The EU's main market regulator aims to harmonize trading among its key dealers and its final report highlights related costs

The European Securities and Monetary Authority (ESMA) has just released its final report on the cost implications of interoperability among central counter party (CCP) and potential systemic risk from participants within the framework aimed at increasing liquidity and regulatory harmonization within EU markets.

Following the 2012 EMIR rules that laid the backbone of the framework, after the 2006 code of conduct for CCP links, interoperability agreements have been established among nearly two dozen dealers, such as exchange members, banks, and interbank brokers, some of whose agreements even pre-dated EMIR – or at least in conception.

CCPs can carry potential systemic exposure when connected to other institutions, and the aim of the interoperability is for CCPs to be able to transact with each other using a cross-link under the agreements that set the rules for how margins and collateral are handled and calculated in different trading and clearing scenarios. The structure is aimed at reducing systemic risk and allowing the flow of trading volumes across key participants who pass those trading abilities to end user brokerages and their clients.  

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The main aim of interoperability arrangements was to open markets to competition at trading and clearing level, according to the report, and seeks to add new trading and clearing actors on to existing venues (grow the space).

CCPs are allowed to have access to trade flow without fragmenting the liquidity via the operability agreements. This is because any trade coming from a trading venue can be cleared either through one CCP, when the relevant clearing members belong to the same CCP, or through the interoperable link when the relevant clearing members belong to each of the interoperable CCPs, according to the report.

The report from ESMA said that potentially all extra costs that CCPs incur due to interoperability could be passed on to their clearing members which may then pass them on to their clients, where relevant.

Also cited was potential risks from agreements between CCPs where the report said the item that could incur the most relevant cost related to the link between CCPs is probably the counterparty credit risk that each CCP incurs due to the interoperability link. It went on to say that the linked CCPs face current and potential future exposures to each other as a result of the process whereby they each net the trades cleared between their participants so as to create novated (net) positions between the CCPs. The nearly 34 page report can be found on the ESMA website. The report is being submitted to the European Commission (EC) which may present it along with other related findings to the European Parliament.

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