STOCK MARKET WATCH -- Tuesday, 18 June 2013

[Demeter]

11. Clearinghouses warn the EU that they're too big to fail.

http://online.wsj.com/article/SB10001424127887323734304578540954221320588.html?mod=dist_smartbrief

European Union finance ministers are expected next week to approve new rules for how to wind down failed financial institutions. But exactly who is covered by the rules remains a moving target. And what could have been an opportunity to establish a rule of law is in danger of becoming a politicized jumble of special preferences, broad regulatory discretion and special-interest pleading.

The latest group to squeal are the derivatives clearinghouses. Following the 2008 financial panic, lawmakers and regulators rushed to push derivatives trading into centralized counterparties. The argument was that this would reduce banks' counterparty risk—the danger that a derivatives contract would not be honored if the institution on the other side of the trade went bust. One of the fears at the height of the panic was that a cascade of failed trades would leave everyone with debilitating losses.

Since then, the EU and the U.S. have adopted rules requiring certain types of derivatives to be cleared through a central counterparty or clearinghouse. This means, in theory, that the clearinghouse takes on the risk that one side of the trade can't pay—while also developing collateral and leverage rules to minimize their own risks.

That's the idea. But as the EU has worked on its "bail-in" rules for failed banks, the clearinghouses have been pushing to be excluded from any losses doled out to creditors of a failed bank. Their argument is that failing to pay the clearinghouses could have systemic consequences. Sound familiar? Some of us warned from the start that centralizing all the counterparty risk wouldn't make it disappear, but would merely create a new kind of too-big-to-fail institution. And so it has come to pass, according to the clearinghouses themselves. The latest draft of the EU's bail-in rules strips the clearinghouses of any special status in a restructuring, and the clearinghouses aren't pleased....