Streetwise Professor Examines “Fundamental Tension” Underlying CCP Resolution Authority

In response to reports that the European Commission (“EC”) is finalizing legislation on Central Counterparty (“CCP”) recovery, University of Houston Finance Professor Craig Pirrong outlined the sources of “fundamental tension” that underlie the final resolution authority. Citing a statement in the EC’s Executive Summary Sheet that the contemplated framework is likely to involve “a public authority taking extraordinary measures in the public interest, possibly overriding normal property rights and allocating losses to specific stakeholders” (emphasis supplied), Professor Pirrong concluded that the prospect of trampled rights “calls into question the prudence of creating and supersizing entities with such latent destructive potential.”

Professor Pirrong argued that the resolution authority potentially will “impose large costs on members of CCPs, and even their customers, [which] raises the burden of being a member, or trading cleared products,” and consequently, disincentivizes membership. He also asserted¬†that “[t]he prospect of dealing with an arbitrary resolution mechanism will affect the behavior of participants in the clearing process even before a CCP fails, and one result could be to accelerate a crisis, as market participants look to cut their exposure to a teetering CCP, and do so in ways that push[] it over the edge.” According to Professor Pirrong, the irony is that these measures to protect CCPs will lead to a “reduced supply of clearing services, and reduced supply of the credit, liquidity and capital that [such CCPs] need to function.”

In addition, Professor Pirrong cautioned that with discretionary power comes “inefficient selective intervention” and the potential to influence costs. “[T]his makes it inevitable,” he warned, that the body will be subjected to intense rent-seeking activity that will mean that its decisions will be driven as much by political factors as efficiency considerations, and perhaps more so: this is particularly true in Europe, where multiple states will push the interests of their firms and citizens.”