Volcker think tank: CCPs should be non-profits

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In a new report that questions the adequacy of post-crisis overhauls, the Volcker Alliance, founded in 2013, urged policy makers to consider a range of regulatory changes including transforming central counterparties, such as CME Group and ICE Clear Credit, into “non-profit utilities” and imposing debt limits on large non-bank institutions.

“While central clearing as mandated by the Dodd-Frank Act has helped make the financial system safer overall, a vast quantity of credit risk has become concentrated in a handful of highly interconnected, systemically important clearinghouses,” the report said, suggesting authorities should improve minimum capital and liquidity standards for CCPs.

A handful of CCPs now clear over 70% of new over-the-counter derivative trades, following regulatory changes that penalise uncleared trades.

The report said CCPs’ for-profit structure could threaten financial stability because it creates an incentive to scrimp on capital and margin requirements to keep trading costs low and attract more business.

“They are deeply conflicted in their role as a for-profit entities and market regulators,” the paper added, noting CCPs’ crucial role in coordinating margin obligations among their trading members during volatile market episodes.

The conclusions of the report, which was foreshadowed at an October WSJ Pro Financial Regulation conference in New York, will chafe with increasingly vocal Republican demands to pare back regulation of the financial system, and they come just days after Fed governor Daniel Tarullo’s strong defence of existing regulations in a speech on December 2.

“Regulators have undertaken serious steps to make the financial system safer and more resilient, but little has been done to confront the risks of short-term debt,” the report said, noting that falling levels of outstanding short-term debt didn’t imply those levels had reached an optimal level.

“Absent more assertive action, short-term debt is likely to again trigger massive panics and bailouts,” it said, suggesting a limit of 5% be put on nonbank financial firms’ short-term debt liabilities as a share of the total.

The report recommends revamping bankruptcy law to prevent fire sales of assets after the failure of a major institution. And it promotes an idea of former Bank of England Governor Mervyn King, included in his 2016 book, to require banks to hold reserves with the central bank in proportion to their deposits, which would make bank runs less likely.

It reiterates Volcker’s previous calls for redrawing of the patchwork, “convoluted” system of US financial regulation, including streamlining and empowering the Financial Stability Oversight Council, which is made up of representatives from nine distinct regulators.

The Office of Financial Research published research last week questioning the effectiveness of post-crisis overhaul efforts, saying that regulators’ focus on the safety of CCPs ignored even greater risks lurking within the financial firms’ balance sheets.

Write to Adam Creighton at Adam.Creighton@dowjones.com

This article was published by WSJ Pro

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