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Bank for International Settlements (BIS) warning regulators - clearing industry systemic risk potential

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The Bank of International Settlements (BIS) has warned regulators and central bankers that some market structures being created by the clearing industry risked creating the potential for systemic risk. However, the report from the Committee on Payment and Settlement Systems (CPSS), consisting of many of the world’s biggest central banks, also found that the ownership and structure of clearing houses made little difference to the risk they posed to global financial stability.

Clearing houses, sometimes known as a central counterparty (CCP), stand between buyers and sellers, ensuring that trades are confirmed and stepping in to complete a transaction if either party defaults. The G20 group of leading economies also wants to open up clearing of the $615,000bn over-the-counter derivatives market to spread risk and increase transparency in the financial system. NYSE Euronext, the US-based operator, has ambitious plans to push into equities and derivatives clearing in London and Paris, and will set up a cash equities clearing house in the French capital, severing its ties with LCH.Clearnet, the London-based clearing house. The London Stock Exchange is considering a similar move into the derivatives clearing market. BIS on Wednesday warned that risks could materialise during the transition as market participants get used to new processes and rules. However it said certain risks were “more likely to occur in certain market structures than in others.” That included concerns that as new entrants move into derivatives clearing, they would compete on price in a race to the bottom, at the expense of strong risk management. “In practice, there is tentative evidence about competition on margin requirements,” it said. “There is also anecdotal evidence that CCPs offer different rates of remuneration based on commercial considerations. These constitute significant risks, which warrant careful attention from regulators or overseers and central banks,” it cautioned. BIS also said there was a fear that the central counterparty, as part of a larger entity, could be considered “too big too fail”. It also said the group could use their market power to restrict alternative trading venues access to clearing houses, echoing concerns raised previously by new entrants to the market such as EuroCCP, the clearing house owned by The Depository Trust and Clearing Corporation of the US. “The broader risk reduction benefits of central clearing may be diluted if market structure changes affect access to central counterparties, raise the cost of central clearing or hamper the process of creating new CCP services,” BIS warned. “This may arise, for example, when CCPs have significant market power, which in itself may be a result of either vertical or horizontal integration,” it said. However, BIS said there was insufficient evidence that one market structure for clearing was superior to another while there appeared to be no clear relationship between user-owned or a non-user-owned, for-profit ownership model and systemic risk.

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