Ex-BoE deputy governor fears ‘utter mayhem’ from clearing houses

Financial regulators risk “utter mayhem” in markets if they do not radically toughen their plans to reform clearing houses, former deputy Bank of England governor Paul Tucker has warned.

Clearing houses, run by companies such as LCH, CME Group and Intercontinental Exchange, have been in the crosshairs of global regulators since the 2008 financial crisis. Their vital role, standing between parties trading trillions of dollars a day and dealing with defaults, has raised concern that they are “too important to fail”.

Earlier this year, the Financial Stability Board issued fresh guidance on how national regulators should manage the failure of one of these businesses. The Systemic Risk Council, a body of former rulemakers and finance experts chaired by Mr Tucker, responded on Friday, decrying the FSB’s efforts as “not fit for purpose” — an unprecedented step for the SRC in what is a rare public spat.

In an interview with the Financial Times after the statement, Mr Tucker said regulators had issued not a standard but a “list” of things to consider.

Owners lack the right incentives to prevent failures, he said, “given that their equity isn’t fully at stake, and we think the plans that they have could in certain circumstances make a crisis worse”.

The SRC — whose members and advisers include former European Central Bank president Jean-Claude Trichet, former US Treasury secretary Paul O’Neill and former Citigroup chief executive John Reed — had proposed a number of measures not included in the FSB’s guidelines, including compelling clearing houses to issue bonds that could be “bailed in” to absorb losses.

Mr Tucker, who was deputy governor at the Bank of England from 2009 to 2013 and is now a fellow at Harvard Kennedy School, said there could be catastrophic consequences if global regulators did not toughen their stance.

Clearing houses “are absolutely at the centre of the modern financial system and there would be utter mayhem [if one collapsed]”, Mr Tucker said. The market tumult this year caused by the coronavirus pandemic was not a good test of clearing houses’ resilience, he said, since “the Federal Reserve came in as buyer of everything”.

“I am optimistic that if the issues are understood, that will help break the logjam,” Mr Tucker added. “It’s quite something for us to say, ‘not fit for purpose’.”

“We will of course consider all responses to the consultation,” the FSB said. The organisation, along with three other global watchdogs, has previously published a range of guidance on the resilience, recovery and resolution of clearing houses.

Banks such as JPMorgan and Société Générale, and asset managers like BlackRock and Vanguard, have called on clearing houses to set more of their own money aside and create more safety buffers. Some are concerned that losses from a failure would be shared among the clearing house’s members, which are largely made up of big investment banks.

In a joint submission to the FSB, the clearing house trade association FIA, the International Swaps and Derivatives Association and global finance lobby group the Institute of International Finance said clearing houses should have “more skin in the game” and be bound by a capital framework.

But the European Association of Clearing Houses said increasing the equity in clearing houses “would create moral hazard, as the clearing house would pay for the risks taken by its members”.