On January 26, 2015, the International Swaps and Derivatives Association (“ISDA”) published a proposed recovery and continuity framework for CCPs. The framework focuses on losses caused to a CCP by the default of one of its clearing participants and not on other losses that a CCP may incur due to, for example, liquidity shortfalls or non-default losses. CCPs are already required to prepare recovery and resolution plans in many jurisdictions. The ISDA recovery and continuity framework sets out proposals for:
- recovery measures that should be available to a CCP which include portfolio auction of a defaulting clearing member's portfolio as part of the default management process, limited cash calls, loss-allocation mechanisms (such as pro-rata reduction in unpaid payment obligations of the CCP) and consideration of a partial contract tear-up to assist a CCP to re- establish a matched book;
- transparency and timing requirements so that recovery measures are clearly defined in the clearing service rule book, providing clearing members with certainty about the maximum time frame for the default management process to run before it is considered to have failed as well as the applicable legal construct, source and utilization of resources;
- considerations for the use of recovery measures beyond pre-funded resources such as cash calls or loss allocation to clearing members;
- requirement for CCPs that offer several clearing services to segregate those services so that there is limited recourse between the services to limit contagion;
- considerations for either partial or full contract tear-up if measures to re-establish a matched book fail;
- compensation by the CCP to clearing members for loss allocation or partial contract tear-up measures through pro-rata shares in the CCP's claims against the estate of defaulting clearing members and future CCP revenues or profits; and
- conditions for entry into resolution of a CCP.
The ISDA paper is available at: http://www2.isda.org/functional-areas/risk-management/.