Public Statements & Remarks

Remarks of Chairman Timothy Massad before the CCP12 Founding Conference and CCP Forum, Shanghai, China

June 7, 2016

Thank you so much for that warm introduction.

I want to thank CCP12 Chairman Lee Betsill and XU Zhen, Chairman of the Shanghai Clearing House’s Board of Directors, for inviting me. I would also like to acknowledge Deputy Governor Pan Gongsheng from the PBOC who is also the head of SAFE, the State Administration of Foreign Exchange; and Ji Zhihong, the Director General of the PBOC Financial Market Department -- and all the other officials and distinguished guests who are here with us today.

It is a pleasure to be here for a number of reasons.

First, I am pleased to help the CCP12 celebrate its registration as a legal entity here in China. By bringing together clearinghouses from all over the world, the CCP12 can play a critical role in one of the most important areas of financial regulatory issues facing us today, and that is ensuring the strength and resilience of clearinghouses.

Second, I am very pleased that today, we were able to commemorate the no-action relief the CFTC staff recently granted to Shanghai Clearing House. This marked the culmination of months of work between our two staffs and the PBOC. Just a few days ago, the CFTC staff announced this relief, which will allow Shanghai Clearing to temporarily clear certain swaps subject to mandatory clearing in China for the proprietary trades of its members that are U.S. persons or affiliates of U.S. persons. This includes RMB interest rate swaps. I was delighted to have the opportunity to meet and speak with Chairman Xu and members of his team this morning, to present the letter providing no-action relief officially and in person.

This relief is designed as an interim measure, as Shanghai Clearing House intends to apply soon for a permanent exemption from registration with respect to such swap clearing. This would be similar to the orders we have issued in the last year for the Japan Securities Clearing Corporation, OTC Clearing Hong Kong Limited, Korea Exchange, and ASX Clear, among others. We welcome this interaction with Shanghai Clearing House and the PBOC, and look forward to continuing to work with them.

Third, it’s a pleasure to be here because I have been very focused on enhancing our interaction with regulators and market participants in China generally. As some of you may know, I just came from Beijing, where I participated in the U.S.-China Strategic and Economic Dialogue. I had good meetings with PBOC Governor Zhou and CSRC Chairman Liu during my time there. This was an important opportunity to further strengthen our relationships with the PBOC and the CSRC and for our two countries generally to enhance coordination and cooperation. This is more important than ever in today’s globalized environment. And it’s particularly important in our area, the regulation of derivatives markets. China is the world’s largest consumer of many physical commodities, and largest producer of certain commodities. And as China develops these markets, they can play a very important role in China’s economy and growth, particularly where the markets can serve the needs of the real economy—that is, the needs of businesses seeking to hedge commercial risk and engage in price discovery. So while our derivatives markets are at different stages of development, there is much we can learn from one another, and there are many ways that we can benefit from increased interaction.

Of course, CCP strength and resilience is one of the areas where collaboration with regulators from across the globe has been immensely beneficial. I can think of no more important issue today – and no better topic to discuss at this CCP12 Conference. So today, I’d like to share a few thoughts on that subject with you, and then I’d be very pleased to take your questions.

Progress in Implementing Clearing Mandates

As you know, a key component of the G-20 leaders’ framework to reform the over-the-counter swaps market in 2009 was to mandate central clearing of standardized swaps. We have made great progress in the implementation of that commitment in just a few short years.

In the United States, clearing is now mandated for most interest rate and credit default swaps. Today, approximately 75 percent of swap transactions are being cleared, as compared to only about 15 percent in 2007. China has mandated clearing of RMB interest rate swaps, Japan has mandated clearing for Yen interest rate swaps, and Hong Kong will soon mandate the clearing of Hong Kong dollar swaps. The implementation of Europe’s mandate begins later this month, and the mandates of other jurisdictions are taking, or will soon take, effect.

The Importance of Clearinghouse Resilience

This very progress has made it imperative that we make sure clearinghouses are strong and resilient.

Some have raised concerns about whether this new emphasis on central clearing is creating new concentrations of risk within the financial system. Some of the more frequently voiced concerns include the following:

  • Are the resources available to cope with a member default adequate? Are the standards regarding margin, capital or “skin in the game,” and the guaranty fund sufficient, or should they be changed in any way?
  • What are the appropriate tools for recovery, and who should be at the table when decisions must be made regarding recovery? What are the necessary and appropriate powers for a resolution authority?
  • What are the interdependencies between clearinghouses, systemically important clearing members, and their affiliates? This is particularly of concern because the largest members are often active at multiple clearinghouses, and they or their affiliates may be providers of services to clearinghouses, such as liquidity facilities payment and settlement services or other services.
  • Do we need a greater “macroprudential framework” when it comes to CCP regulation?

I believe that it is possible to devise good, pragmatic approaches to all of these concerns, and I believe we have already accomplished a great deal in that regard. So I would like to briefly highlight how far we’ve come, and then offer some thoughts on where we are going.

CFTC’s Domestic Efforts

In the United States, we at the CFTC have been involved in the oversight of clearinghouses for many years. And since the global financial crisis, we have been particularly focused on the resiliency of clearinghouses.

We have substantially strengthened our requirements regarding risk management and transparency. We did an extensive revision of our rules and incorporated international standards—the Principles for Financial Market Infrastructures, or PFMIs-- into our regulations. We strengthened customer protection measures. And we have enhanced our examination, compliance, and risk surveillance programs.

We are also actively working on recovery and resolution planning and the adequacy of resources and procedures applicable in the event of a major problem. This includes exploring auction procedures to increase efficiency and participation; considering whether and under what circumstances gains-based haircutting is an appropriate tool to allocate losses; examining the tools available to a clearinghouse, such as juniorization and partial tear-ups, in order to ensure that they can re-establish a matched book; and discussing the governance mechanisms over the use of recovery tools – and the transparency regarding the potential use of those tools. We are also working with other U.S. regulators on resolution planning.

International Efforts

Internationally there has been great progress as well. The development of the PFMIs themselves was a major advance in addressing CCP resilience. And this has been supplemented by subsequent guidance, including guidance on Recovery of Financial Market Infrastructures and on quantitative disclosures. CCP12 and its members have provided vital support in the development and implementation of these important resilience measures.

Overall CCP oversight also requires working together cooperatively and collaboratively across borders in bilateral ways.

One important example of international cooperation was the recent agreement European Commissioner Jonathan Hill and I reached in February, which sets forth a common approach regarding requirements for CCPs. This agreement resolves the issues that were standing in the way of Europe “recognizing” U.S. CCPs. And it thereby helps to make sure that the U.S. and European derivatives markets can continue to be dynamic, with robust competition and liquidity across borders.

Another example is the work I mentioned earlier on registration and exemptions from registration for CCPs located outside the United States that wish to clear swaps for their U.S. clearing members. We look forward to working with Shanghai Clearing on this as well.

Multilateral Work on CCP Resilience, Recovery and Resolution

There is much more going on with respect to CCP resilience across borders internationally. As many of you know, last year the chairs of the Financial Stability Board, the Committee on Payments and Market Infrastructures (CPMI), the International Organization of Securities Commissions (IOSCO) and the Basel Committee on Banking Supervision agreed to a CCP work plan that has four major elements. We are co-chairing some of this work and participating in all of it.

The first element involves examining if the regulatory standards set forth in the PFMIs should be enhanced to increase CCP resilience. This includes looking at margin methodologies and the resources available to a clearinghouse in the event of a default, including “skin in the game.” And it includes looking at standards for stress tests, liquidity arrangements of CCPs, and issues relating to CCP governance. This work has benefitted from responses to two extensive surveys submitted by more than 30 CCPs, many of which are part of the CCP12, so I thank you for your participation in that effort.

The second element is to assess the adequacy of CCP recovery tools and plans. And there is related work going on to assess the implementation of the PFMIs across many jurisdictions. Reports on this work will be issued later this summer.

The third is developing standards for credible resolution strategies. This working group is expected to issue draft standards or guidance for public consultation later this year.

And another group is carrying out the fourth element, which is examining the interdependencies between CCPs and large clearing members.

Of course, clearinghouses have themselves been focused on these issues – particularly since the crisis. This kind of dialogue – among clearinghouses, market participants, and regulators – is precisely what we need to address these issues.

Some Thoughts on the Way Forward

All this work covers many issues worthy of discussion at this conference. I cannot cover them all, so let me highlight a few key considerations I believe we should keep in mind so that we maintain our perspective, and not lose sight of the forest for the trees.

Daily Risk Management is the Key to Resilience. While we need to plan for recovery and resolution of a clearinghouse, we must remember that clearinghouse resiliency is primarily about daily risk management. Often times, the activities that comprise ongoing risk management don’t get much attention when we talk about clearinghouse resiliency. But those activities, carried out by the clearinghouse, clearing members and regulators, are essential. I’m referring to daily margining practices, stress and back testing, oversight, and ongoing risk surveillance. No recovery plan — and no set of rules – can take the place of these everyday activities. And because these activities involve the clearinghouse and its members—which do not always have identical interests and incentives — transparency and proper governance around these issues are critical also.

Continuity is Critical in the Event of a Default. In the event a clearinghouse faces a significant default, continuity of critical functions is vital. Therefore, as we engage in contingency planning, we must consider a number of different scenarios and challenges.

For example, if there is a default or other problem, we need clearing to continue to permit the continued operation of the markets. In particular, clearing is necessary so that the price discovery provided by exchange-traded instruments can continue. We also need a robust set of healthy clearing members that are able – and willing – to accept transfers of the positions of customers of the defaulter, to avoid a more general liquidation that could roil the markets. We must also plan for what would happen in the event of a default by a clearing member whose affiliate is critical to the provision of custody or settlement services. This is one reason why the work on interdependencies is important.

Some have said that the importance of continuity of clearing is why we need more than one clearinghouse for each product. But that may be difficult to achieve in practice in many cases. In futures, liquidity is often specific to a particular product at a particular exchange.

Resolution Plans Must Be Designed to Encourage Recovery. Recovery and resolution planning are seen as a continuum: if a CCP can’t get back to a matched book and replenish its resources through recovery tools, then we must invoke a resolution plan. Resolution may also be invoked if the resolution authority determines that the use of available recovery tools is likely to compromise financial stability.

Resolution does not mean liquidation in this context, but rather a phase where a government authority with certain resolution-related powers steps in to ensure the continuity of critical functions. Much of the discussion of resolution focuses on questions like: at what point should a resolution authority intervene? Should there be specific tools and resources reserved for exercise by the resolution authority in the resolution phase? What is the proper balance between giving the resolution authority flexibility and having predictability regarding tools, potential assessments, or other features? If resolution is invoked to avoid the use of recovery tools that might compromise financial stability, how can we ensure that the resolution authority’s use of its own tools won’t have a similar effect?

These are appropriate questions to ask. And in addressing those issues, we must remember that the incentives that may be created by resolution plans —intentionally or not — can create or affect recovery prospects. If, for example, clearing members believe they will get a better outcome in resolution than in recovery, then they may have an incentive not to facilitate recovery. That is, they may be less willing to step up to bid in an auction or take on positions of a defaulting member if they think that under resolution, they would absorb fewer losses. They may not be as willing to support replenishing a CCP’s resources in recovery if in resolution they expect to get more in return for doing so. So our resolution planning must not create incentives that undermine recovery.

It’s Not Just About the CCP. The issues of CCP resilience, recovery and resolution involve clearing members, not just the CCP. And in systems where clearing members stand behind transactions, the robustness of the clearing member industry is critical to the success of central clearing and the health of CCPs. We cannot ensure resilience simply by minimizing the risk of failure of particular institutions; we must take a holistic perspective, and consider the overall system, its overall resilience, and its ability to respond if there is a problem.

This is obvious when we think about what happens if there is a default by a clearing member. For example, when firms like Lehman Brothers and MF Global collapsed, clearinghouses were able to run successful auctions and transfer customers’ positions to other firms quickly and seamlessly. Other clearing members were able to step up. We must continue to have that ability today.

There are many factors that affect the ability of the clearing member industry to respond, as it has in the past, to mitigate the risk of contagion effects of a member default. One that has received some attention is the potential effect of the leverage ratio on incentives to clear as well as its impact on clearing capacity itself. This turns on how the leverage ratio measures a clearing member’s exposure arising from cleared derivatives, and whether the risk-reducing properties of CCP margin are recognized. Let me make clear that I support strong capital requirements, but I do think we must consider the effects the leverage ratio may have on clearing. This is particularly true in the context of a default by a clearing member.

That is, the other clearing members may be reluctant or unable to take on the customers of a defaulting clearing member, or to bid for positions in an auction, even though those positions are accompanied by suitable margin to mitigate default risk, because that margin is not credited against its leverage ratio. That could increase the risk arising from the default, in what could already be a stressed market.

I am pleased to see that the Basel Committee is currently doing a consultation on the leverage ratio.

Is There a Need for A Greater Macroprudential Framework? Finally, there has been some attention paid recently to whether we need a greater “macroprudential framework” for CCP regulation. Generally, this refers to regulation with the objective of mitigating systemic risk, and with a scope that includes the financial system generally, rather than a focus on individual entities.

First I would note that macroprudential considerations are already present in CCP regulation.

For example, the PFMIs require a CCP to have robust risk controls and contingency plans that are appropriate to minimize the risk of widespread disruptions to the larger financial system.  And I think much of the international work currently going on regarding CCPs will address these concerns.

But these workstreams remind us that this is a challenging task—one that is very much a work in progress. For example, developing appropriately tailored measures to limit pro-cyclicality is a task that is in its preliminary stages.

Authorities are also considering the concept of regulatory stress tests – not a one-size-fits-all stress test to measure individual CCPs against, but stress tests that consider the impact of stressful events across multiple clearing members at multiple CCPs. These too create challenges, in terms of designing appropriate cross-CCP scenarios.

So I believe we should continue to explore these issues but also recognize the challenges.


I want to leave time for a few questions, so let me conclude on this note: Central clearing remains one of the great innovations of modern finance. And the work going on today on CCPs is critical to making sure the model of central clearing remains sound, and our financial system remains strong. That is important, as our task should be to not just fix the failures of the past, but to create a framework for the growth and innovation of the future.

It has been a pleasure being with you – and I wish the CCP12 continued success in the years to come.

Thank you.

Last Updated: June 7, 2016