Trade exposures with CCPs - CRR Provision

In which the Capital Requirements Regulation 575/2013 (EUR Lex)) requires that, for a clearing member to achieve a zero weighting on its exchange traded derivatives clearing business, it must first be able to pass losses occasioned by the default of a CCP on to its client.

306(1). An institution shall apply the following treatment to its trade exposures with CCPs:

306(1)(a) it shall apply a risk weight of 2 % to the exposure values of all its trade exposures with QCCPs;

306(1)(b) it shall apply the risk weight used for the Standardised Approach to credit risk as set out in Article 107(2)(b) to all its trade exposures with non-qualifying CCPs;

306(1)(c) where an institution is acting as a financial intermediary between a client and a CCP and the terms of the CCP-related transaction stipulate that the institution is not obligated to reimburse the client for any losses suffered due to changes in the value of that transaction in the event that the CCP defaults, the exposure value of the transaction with the CCP that corresponds to that CCP-related transaction is equal to zero.

— Section 306(1), CRR

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Discussion

The clearing member’s own negligence, fraud or wilful default

But it will be a generous client indeed who does not insist on a carve-out from that right for defaults caused by the clearing member's own negligence, wilful default or fraud. Would such a carve-out invalidate an application of 306(1)(c)?

Respectfully, it is submitted, it would not:

It is clear in 306(1)(c) that the CCP must have defaulted under the transaction (i.e., more than being generally “in default” in the abstract, in the sense of being “insolvent”). Of course, a CCP’s Insolvency would come into play if it led to a default (which ordinarily it would, unless the contract had already been breached by the clearing member, in a way that, of itself, brought about the CCP’s insolvency!)

It ought to be safe to say any negligence (whether or not gross), wilful default or fraud on behalf of the clearing member in carrying out its obligations under the transaction with the CCP would, QED, be a default under that transaction by the clearing member: (any action it was entitled to take under the trasnaction, could hardly be “negligent” as far as the CCP was concerned).

So a loss to the clearing member which arose out of the CCP’s inability to perform under a transaction which, in turn, came about as a result of the clearing member defaulting to that CCP would not be “loss suffered in the event that CCP defaults”: if the clearing member sued the CCP for that loss, it would fail.

Looking at it another way, if such a carve-out did invalidate 306(1)(c) then the provision would have no application at all, because it would be commercially impossible to remove it.

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