Central counterparties: from the bank-sovereign nexus to a credible recovery and resolution regime

This dissertation argues on the necessity for an efficient and credible recovery and resolution framework for central clearing counterparties (CCPs).Following the 2008 subprime crisis and the failure of Lehman Brothers, several reforms have been undertaken in order to reinforce the strength of the financial system and, in particular, the over the counter (OTC) derivatives market. Two streams of reforms are of particular relevance in the present context: a) The development of resolution regimes for financial institutions, in particular for systemic “too big to fail” banks. The key objectives of these resolution regimes are to ensure the continuity of the critical functions performed by systemic institutions, the preservation of financial stability and the protection of taxpayers (i.e. avoiding public bailouts). This stream completed regulatory initiatives to reinforce the existing prudential framework acknowledging the natural limits of the latter and the observed forbearance by supervisory authorities in the aftermath of the financial crisis. The academic literature analysing the development and implementation of resolution regimes for banks essentially looked at issues such as the respect of the shareholders’ fundamental rights, the existence of appropriate safeguards for creditors and the execution of bail-in operations. b) The obligation to clear centrally OTC derivatives markets in order to prevent and control the possible contagion of risks across the financial system. The objectives of this stream of reform are to increase the transparency of the OTC derivatives markets and reduce the counterparty credit risk in the system by forcing transactions through professional risk managers, i.e. central clearing counterparties (CCPs). This however assumes that CCPs have the capability and the capacity to manage this centralisation of risks. Therefore, the literature showed interest in the risk management practices of CCPs, in particular margining methodologies, and agency problems created by the ownership structure and the loss allocation mechanisms of CCPs, in particular analysing the effects of a CCP’s skin-in-the-game (i.e. own contributions to the loss allocation mechanisms) on the incentives of shareholders and clearing members. Although recent history has been rather merciful in terms of CCPs' failures, the inherent cross-border and international nature of their activities, their level of interconnectedness with other financial institutions and their growing importance following the G20 commitments on OTC derivatives make them critical nodes of the financial system. It is therefore important to consider carefully the recovery and resolution of CCPs that actually stands at the crossroad of the two streams of regulatory reforms mentioned above and completes them. Similarly, this dissertation intends to build the bridge between the literature on CCPs and the literature on banks’ recovery and resolution. It aims at providing a better understanding of the resolution framework developed for CCPs, associated policy choices and possible issues with a specific insight on the situation in Europe.