Streetwise Professor Craig Pirrong on CFTC Rule Regarding CCP Qualifying Liquid Resources
Commentary by Bob Zwirb
University of Houston finance professor Craig Pirrong has written a commentary analyzing the new CFTC Rule 39.33, which mandates that collateral be subject to a "prearranged and highly reliable funding arrangement." The rule, which requires systematically important derivatives clearing organizations in the form of Treasuries in the form of Treasuries ("SIDCOs") to maintain sufficient liquidity resources, does not treat U.S. Treasury securities as a qualifying liquid resource. Instead, such organizations can count Treasuries towards their liquid resources only if they are backed by highly reliable funding arrangements such as committed lines of credit from banks. Thus, under the CFTC rule, Treasuries will no longer be treated as equivalent to cash. Pirrong argues that this requirement makes little economic sense, since Treasuries are a better source of liquidity than bank credit lines during times of financial stress. He also states that mandating that SIDCOs obtain lines of credit from banks will impose substantial costs on such CCPs in the form of capital charges, increase the interconnectedness among financial institutions that serve as a source of contagion from derivatives defaults, and "undermine incentives of SIDCOs to demand the posting of high quality collateral." Pirrong concludes by stating that, given the cost of the mandated credit lines, the rule will constitute "a dead weight burden on the markets."
See: "All Pain, No Gain: The CFTC's Rule on CCP Qualifying Liquid Resources," Streetwise Professor.
Related news: CFTC Issues Final Rules for Derivatives Clearing Organizations to Align with International Standards (Pre-Fed. Reg.) (November 15, 2013).
Commentary
Federal Reserve Governor Jerome H. Powell recently highlighted some of the risks created by central clearing, including that of "concentrating risk in a central counterparty [that] could create a single point of failure for the entire [financial] system." See Fed. Governor Jerome H. Powell Delivers Speech Regarding OTC Market Infrastructure Opportunities and Challenges (with Lofchie Comment), November 21, 2013. This concern seems to be exacerbated by the CFTC's mandate that SIDCOs obtain credit lines with banks, which, if Professor Pirrong is correct, will concentrate risk even more. For a Chairman who has campaigned to reduce interconnectedness in the financial markets in order to make them safer, the Dodd-Frank clearing mandate combined with this rule may be counterproductive. The rule also appears to be a significant issue from a competitive perspective, as it has already caused the CME Group to threaten to move "a significant portion" of its clearing business offshore "to maintain cost parity with its non-US competitors."