CFTC Publishes Final Rules for Derivatives Clearing Organizations to Align with International Standards (Fed. Reg. Version) (with Lofchie Comment and YouTube Selection)

The CFTC published in the Federal Register the finalized version of rules which establish international standards for systemically important derivatives clearing organizations (SIDCOs). According to the CFTC, the new rules, in conjunction with existing derivative clearing rules, establish regulations that are consistent with the Principles for Financial Market Infrastructures (PFMIs). This will allow U.S. SIDCOs to continue to be Qualifying Central Counterparties for purposes of international bank capital standards. The new rules include provisions concerning procedural requirements for opting in to the regulatory regime, as well as substantive requirements relating to governance, financial resources, system safeguards, special default rules and procedures for uncovered losses or short falls, risk management, additional disclosure requirements, efficiency and recovery and wind-down procedures.

Lofchie Comment: The aspect of these rules that has received the most negative market commentary and negative academic attention (and deservedly so) is the provision that a clearing corporation may not treat U.S. Treasury Securities as inherently good collateral. Rather, U.S. Treasuries may be treated as good collateral only "convertible into cash pursuant to prearranged and highly reliable funding arrangements." Apparently, the CFTC believes that not only cockroaches, rats and North Dakotans with very deep shelters will survive a nuclear holocaust and the downfall of the U.S. government: so will CFTC-regulated clearing corporations. Unfortunately, most market participants are not likely to do as well, so preserving the clearing corporations is not much of a benefit. See also YouTube Selection. Other than the general absurdity of believing that clearing corporations may continue to function notwithstanding the failure of the U.S. government, this rule highlights one of the major systemic risks that clearing corporations create for the rest of the financial system.Because banks and other clearing members have no ability to negotiate any limits on the amount of collateral that can be required of them from a clearing agency, including at a time of market volatility and a liquidity crunch, the legally unrestrained demand for clearing corporations for more cash margin (not even Treasuries are good enough) in order to protect themselves has the potential to drain collateral and liquidity from the banking system and from the economy generally. In short, the clearing corporations may have the power to save themselves by throwing the banking system overboard.For a more economically learned expression of the concern expressed above: see All Pain, No Gain: the CFTC's Rule on Qualifying Liquid Resourches; Some of Cassandra's (AKA SWP's) Warnings on Clearing Begin to Take Hold; Speech by Federal Reserve Governor Powell: OTC Infrastructure Reform: Opportunities and Challenges. Also consider these questions: when Congress mandated central clearing under Dodd-Frank, did it in fact have time to consider whether mandated central clearing would in fact reduce system risk? What was the body of evidence that it considered? What were the scenarios taht it considered? What if Congress made a mistake?

See: 78 FR 72476.Related News: CFTC Issues Final Rules for Derivatives Clearing Organizations to Align with International Standards (Pre-Fed. Reg.) (November 15, 2013).