Recovery and Resolution: Uneven Bars for CCPs and Banks

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Mike Alix, Adam Gilbert, and Armen Meyer.

The CFTC last month issued extensive new recovery and resolution planning guidance (CFTC Guidance) for central counterparty clearinghouses (CCPs). [1] While banks and insurance companies have recently received some relief with respect to their resolution plans, [2] the CFTC Guidance significantly raises the bar on the depth and breadth of detail and analysis expected for CCPs.

The CFTC was the first CCP supervisor to finalize a rule (in 2013) establishing recovery and resolution planning requirements. [3] The CFTC Guidance significantly expands on the 2013 rule and demonstrates that the CFTC is once again leading the advancement of CCPs’ recovery and resolution planning. Although this guidance only applies to the CFTC-regulated CCPs, it is likely to be followed (in at least some respects) by other CCP regulators given CCPs’ increasing importance to the global financial infrastructure.

In fact, international standard setters released new documents this week concerning the financial and operational resilience of CCPs. [4] The Financial Stability Board (FSB) issued a series of questions for the industry on CCP resolution planning, which will be incorporated in FSB guidance to be released in 2017. Further, the Committee on Payments and Market Infrastructure and the International Organization of Securities Commissions (CPMI/IOSCO) published reports identifying several areas for improvement in the recovery practices of ten CCPs, as well as further guidance on risk management standards that they had issued in 2014. [5] Even US policymakers have expressed interest in CCPs recently with Senator Mark Warner, Senator Elizabeth Warren, and Representative Elijah Cummings requesting information from two systemically important CCPs on their recovery and resolution plans.

As most major financial institutions are clearing members of at least one systemically important CCP and are dependent on them for clearing and settling of transactions, increased costs faced by CCPs are likely to have impact throughout the industry. However, under the CFTC Guidance, clearing members will gain the opportunity to provide input into the CCPs’ plans.

This post analyzes the key ways in which the CFTC has raised expectations for CCPs’ recovery and resolution plans, and provides our view of next steps.

Expanded recovery and resolution requirements

The CFTC Guidance not only significantly raises the bar on the depth and breadth of CCPs’ resolution and recovery plans, it also goes materially beyond comparable bank guidance. [6] The following five areas of the CFTC Guidance will be among the most challenging for these CCPs to implement.

Plans must analyze at least eight risk scenarios, not limited to idiosyncratic stress situations

The CFTC Guidance requires detailed analysis and recovery planning for a minimum of eight business and operational risk scenarios, in addition to risk scenarios resulting from a clearing member default. This requirement goes well beyond the 2013 rule, which only required CCPs to maintain recovery plans which would account for (1) credit losses and liquidity shortfalls and (2) general business, operational, or other risks that threaten the CCP’s viability. Furthermore, CCPs may need to analyze even more scenarios than these eight since the CFTC Guidance underscores a requirement that the CCP must additionally determine the full range of distinct risks that could require it to activate a recovery plan (each, a “recovery scenario”). [7]

Eight required risk scenarios

  1. A settlement bank failure
  2. A custodian bank failure
  3. Scenarios resulting from investment risk
  4. Poor business results
  5. The financial effects of cybersecurity events
  6. Internal fraud, external fraud, and/or other actions of criminals or public enemies
  7. Legal liability not specific to the CCP’s business as a CCP (e.g., tort liability, liability related to intellectual property)
  8. Losses resulting from interconnections and interdependencies among the CCP and its parent, affiliates, and/or internal or external service providers (e.g., the financial effects of the inability of an internal service provider to supply key systems or services to the CCP)

The CFTC Guidance goes further than guidance for banks which requires them to consider “a wide range of internal and external stresses” rather than prescribing risk scenarios. It also calls for CCPs to consider systemic stress events in their scenarios, which banks similarly do not have to do (although banks must incorporate a severely adverse macro-economic environment). Meeting the CFTC Guidance in this respect will be difficult for CCPs, especially without any assumption of government or programmatic support of the financial system (not specific firms).

Multiple considerations prescribed for each risk scenario, including sequential action plans

Each risk scenario must have a separate recovery analysis which incorporates a minimum of 13 specified considerations. These considerations include detail on (1) the specific sequential actions that the CCP would take for each risk scenario, (2) the governance framework that the CCP would follow to execute the actions, and (3) the financial and operational impact of each action on the CCP, its clearing members, internal and external service providers, and relevant affiliated companies. Although typical bank recovery plans include a potentially lengthy menu of recovery options, the banks are not required to pre-determine precisely which recovery actions would be taken (and in what order) for each possible risk scenario. See the Appendix below for the list of all 13 considerations.

With respect to resolution, the CCP must first describe the point at which it would transition from recovery to resolution. This expectation also differs from that for banks, which currently have separate recovery and resolution planning requirements (although there is evidence of a trend toward convergence of recovery and resolution planning, and associated risk governance). Similar to the recovery analysis, 12 considerations are required for each wind-down option including (1) any options to sell, transfer, or otherwise permanently cease operations and (2) detail on how each of those options would be executed.

Severe risk scenarios could mean more resources, and higher costs for clearing members

CCPs will need to conduct a detailed analysis of the financial and operational resources required to execute each recovery and wind-down option. Given the severity of the scenarios that must be contemplated, including systemic events, the CCP’s analysis may show that it will need additional financial resources in order to execute a recovery or an orderly wind-down. If additional resources are needed, CCPs would likely pass those costs on to their clearing members, either directly or indirectly.

Feasibility testing will result in stronger plans, but also more work

Regular feasibility testing of recovery and wind-down plans is introduced for the first time in the CFTC Guidance. The plans must describe the type of testing performed, including the frequency, methodology, and utilization of the testing results. Feasibility testing has proven to be a very useful tool, often resulting in the identification of gaps or desired enhancements. However, feasibility testing also requires dedication of significant resources and the involvement of clearing members, which could further impact costs for all parties.

Industry coordination and more transparency

Although the CFTC Guidance does not mandate a public section of the recovery and resolution plans, as is required for banks, the CFTC Guidance effectively mandates even greater transparency by requiring CCPs to involve their clearing members in the development, review, and updating of its plans, including feasibility testing, where applicable. The CCPs are asked to detail their clearing members’ involvement in recovery and resolution plan development and governance, and also to address how recovery and wind-down actions are included in the clearinghouse’s rule book. Due to the many clearing members CCPs have, [8] coordinating with them to meet this requirement will provide a great deal of transparency into CCP operations and resilience for the industry.

Next steps

The CFTC Guidance provides welcomed specificity around concepts set forth in the CFTC’s 2013 rule, which was brief and nonprescriptive. Given the severity of required scenarios, including systemic events, recovery and resolution planning holds the potential to unearth the need for CCPs to hold more capital or liquidity, or possibly to have access to additional contingent financial resources.

While the guidance is silent on the effective date, we believe that fully implementing this guidance will be a multi-year iterative process and will involve a very significant dedication of CCP resources. As such, we recommend that CCPs begin to scope out this effort, develop the work plan, and begin work on those areas that will require the most effort such as scenario creation and the detailed analysis.


A baker’s dozen of considerations for each recovery scenario

The CFTC Guidance delineates 13 elements that should be identified and analyzed for each recovery scenario:

  1. The particular recovery tools that the CCP would expect to use in for that scenario
  2. The specific order in which the CCP would expect to use such tools; the event that would trigger the use of each tool in the sequence; and any discretion that the CCP has in the use and/or sequencing of the tools, the parameters for the exercise of such discretion, the factors that guide such discretion and the governance processes for the exercise of such discretion
  3. Whether each tool is mandatory or voluntary
  4. The specific steps that would be required to implement each tool
  5. The roles, obligations, and responsibilities of the parties that are involved in the use of each tool
  6. The time frame within which each tool could be used
  7. The key risks associated with the use of each tool
  8. The steps that the CCP would expect to take before an event occurs to mitigate such identified risks
  9. Any constraints on the use or effectiveness of each tool
  10. An evaluation of the likelihood that, given the factors identified in 8–9 above, the recovery tool would be effective within the relevant timeframe
  11. The expected impact on the CCP, its clearing members and their customers, its parent, affiliates, and owners, and the financial system more broadly if a particular tool is used; the manner in which the CCP would mitigate any adverse impacts; and the mechanisms by which the CCP would enable its clearing members to understand, measure, manage, and control the exposure created by the tool
  12. Any incentives that would be created by the availability or the use of the tool
  13. The relevant rules or rule amendments that support (or are needed to support) the use of each tool


[1] The CFTC uses the term “Derivative Clearing Organization” (DCO) to refer to the CCPs it regulates. The DCOs subject to the CFTC Guidance are the two designated as systemically important by the Financial Stability Oversight Council (FSOC) (i.e., the Chicago Mercantile Exchange (CME) and ICE Clear Credit (ICE)) and those that opt-in in order to achieve “Qualified CCP” status (which provides favorable capital treatment to the QCCPs’ clearing members). CME and ICE are among the five CCPs (along with three other financial market utilities, together “Systemically Important Financial Market Utilities” or “SIFMUs”) that the FSOC designated as systemically important in 2012. The other SIFMUs are not directly subject to the CFTC Guidance, as they are regulated by the SEC or the Federal Reserve. See PwC’s Regulatory brief: More Scrutiny for Financial Market Utilities (May 2013) for more information.
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[2] Last April, the Federal Reserve and FDIC (Agencies) released feedback that was highly critical of the eight July-filing domestic banks (generally, those US banks with over $250 billion in nonbank assets) and found five of their resolution plans to be “not credible.” At the same time, the Agencies provided some relief by delaying these banks’ next filing date to July 2017. See our post, Agencies’ Resolution Plan Feedback (April 2016). Then in June, the Agencies similarly delayed the four July-filing foreign banks’ next filing date to July 2017, and at the same time issued guidance allowing 84 December-filing banks with limited US operations to file “reduced content” plans for the next three years, beginning on December 31, 2016. See PwC’s First take: Five key points from the Agencies’ FBO resolution plan announcements (June 2016). Finally, this month, the Agencies delayed the filing date for the remaining 38 December-filing institutions (36 banks and two insurance companies) to December 2017 in order to allow them adequate time to incorporate feedback to plans filed in December 2015, which we expect the Agencies to provide by year-end. Overall, we believe these deferrals free the Agencies to focus their attention on the July-filing banks’ plans over the next year and may be an indirect acknowledgement that the annual plan submission cycle is not effective for either the banks or the Agencies.
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[3] Under the 2013 rule, CCPs were required to establish their recovery and resolution plans by December 31, 2013. For more information, see PwC’s Regulatory brief, Systemically important derivatives clearing organizations: The CFTC proposes recovery and wind-down plans (September 2013).
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[4] The international standard setters have provided further detail on some of their expectations for CCP recovery and resolution. Nonetheless, the CFTC’s latest guidance sets a higher bar for CCPs in most respects.
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[5] The FSB and CPMI/IOSCO publications build off of their prior 2014 issuances which are discussed in our post, Financial Market Utilities: Is the System Safer? (February 2015).
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[6] For an analysis of bank resolution planning and recovery guidance, see our posts: Agencies’ Resolution Plan Feedback (April 2016) and OCC’s Recovery Planning Proposal (December 2015); as well as PwC’s Ten key points from the FDIC’s resolution plan guidance (December 2014) and Ten key points from regulators’ feedback to Wave 1 resolution plan filers (August 2014). See also PwC’s Regulatory brief, Recovery planning: Until the last gasp (October 2014).
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[7] However, the CFTC Guidance noted that CCPs do not need to analyze the large range of market risk scenarios that are used for capital and liquidity stress testing purposes. See PwC’s First take, Five key points from the 2016 Comprehensive Capital Analysis and Review (June 2016).
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[8] CME and ICE each have at least 30 clearing members.
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