Rules that keep each central counterparty safe can, on their own, push danger into the wider financial system, the Bank of England’s Sarah Breeden has warned.
Sarah Breeden, deputy governor for financial stability of the Bank of England, told ISDA’s annual meeting on 14 May that looking only at the health of an individual clearing house risks missing problems building up elsewhere. “Ensuring the stability of individual CCPs, while necessary, is not sufficient for financial stability,” she said.
She pointed to margin policy as a clear example. “Margining practices are a key example where actions of one firm, although prudent from an individual, micro-prudential, firm perspective, have the potential to contribute to macro-prudential financial-stability risks,” Breeden explained.
When markets turn, higher margin calls can drain cash from traders and force them to sell assets. “These dynamics contributed to stress during the dash for cash episode in 2020,” she recalled.
Portfolio margining can have a similar effect. It allows firms to offset risks across products, but can also procyclically boost borrowing. “Take for example the cash-futures basis trade, where the amount of leverage a participant can take depends on both the repo haircut and the initial margin rate of the future,” she noted, warning that such leverage can amplify shocks if correlations break down.
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Breeden set out international work to make margin demands more predictable and to test whether non-banks have enough liquidity. “This year, we will start to implement the recommendations domestically and continue working with international standard-setting bodies to embed the proposals into the existing frameworks,” she said.
The Bank will also turn to the gilt repo market, where sudden strains have surfaced since 2022. “We will start a conversation with industry via a Discussion Paper later this year on possible reforms to market structure to enhance gilt repo market resilience,” Breeden announced, inviting feedback on ideas such as greater central clearing and minimum haircuts.
She closed by underlining the need for a wider lens: “A macro-prudential approach to the supervision of CCPs is essential given their central role in the financial system.”
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