Central counterparties in financial difficulties
Central counterparties (CCPs) are institutions that sit between the buyers and sellers of financial contracts, providing assurance that the obligations under those contracts will be fulfilled. This reduces risks to the financial system associated with counterparty default. The process of transacting through a CCP is known as "clearing". Firms can access CCPs’ clearing services either by becoming a "clearing member" of a CCP, or a client of a clearing member. Clearing members are typically large international institutions, such as banks, who can then offer clearing services to individual clients. Clients tend to be medium and large sized financial and non-financial firms.
	Following the global financial crisis starting in 2007, the "clearing obligation" was introduced to increase the use of CCPs for clearing and reduce the overall counterparty risk in the market. Firms subject to the clearing obligation are legally required to access clearing services for certain transactions. Since the introduction of this requirement, the volume of clearing at CCPs, both in the UK and abroad, has increased significantly. UK CCPs have consistently shown resilience during times of market stress but, due to the systemic nature of CCPs and the interconnectivity and increased volume of trades cleared through them, the government considers that it is important to ensure that the UK has a robust regime to manage the failure of a CCP in the event that it did occur, in a way that minimises risks to the wider financial system, the economy, and public funds.
	The UK’s existing resolution regime for CCPs was introduced in 2014. It provides the Bank with a limited set of powers which allow it to transfer the property or ownership of a CCP. After the use of these powers, the Bank remains reliant on the powers available under the CCP’s own rulebook to allocate losses and ensure the continued operation of the CCP.
	CCPs have various resources, tools and plans in place to help mitigate against the risk of a clearing member defaulting. In order to clear through a CCP, clearing members must provide collateral to cover their transactions, known as initial margin (IM), which the CCP will use to meet payment obligations to the other side of the contract in the event that a clearing member defaults. How much IM a clearing member is required to provide is calculated based on a number of factors, including the riskiness of the clearing member’s portfolio.
	All clearing members are also required to contribute to a further mutualised pool of financial resources, known as the default fund. In the event that a defaulting clearing member’s initial margin is insufficient to cover the loss resulting from their default, then the default fund is used to absorb the loss. The defaulter’s own contribution is exposed first, followed by part of the CCP’s own capital (known as "skin in the game"), and then default fund contributions from other clearing members are used.
	In 2017 the Financial Stability Board (FSB) published guidance for recovery and resolution of CCPs. The FSB is an international body that promotes international financial stability and works towards developing strong regulatory, supervisory and other financial sector policies. The guidance sets out the tools and powers that should be provided to resolution authorities. As the UK’s current regime was introduced in 2014, it is not aligned with the FSB’s most recent guidance. The Act therefore brings the UK in line with the most recent FSB guidance, which seeks to ensure that resolution authorities have the appropriate flexibility needed to a resolve a CCP in the most effective way.