Non-US clearing houses should be wary of 'politicised' Federal Reserve

Fordham Global Foresight published this week a paper titled “Thin Ice, Black Ice or Both?” which looks at the implications of an increasingly politicised Federal Reserve and a Trump-led US Treasury for global market stability.

Martyn Brush, the co-founder of the advisory group and its head of financial risk, argued in the report that non-US clearing houses and their members, and even non-US central banks should think about the possibility that the US might not back them in a crisis.

Brush wrote: “While the Fed can provide indirect support to non-bank entities in pressing circumstances, clearing houses do not need funding—they need a place to sell exposures. Indeed, even if the Fed did want to provide emergency liquidity to clearing houses, it is only possible via Section 13(3) of the Federal Reserve Act.”

That section of the Federal Reserve Act would require the explicit approval of the US Treasury, Brush said.

“Here, there’s a need to consider how the significant friction between President Trump and Fed chairman Jerome Powell could manifest. Given the differences between the two, whether the Trump Treasury and the Plunge Protection Team can be counted on to act is anyone’s guess.

“Let’s say you have a foreign clearing house with a sizeable US membership. Would the Fed provide position liquidation support to the host regulator, or could it take its cue from the executive branch and choose not to intervene?”

The paper goes on to consider if the Fed might be slow to act in the event of a major market event due to “pressure from the Trump Treasury”.

Brush added: “If so, there is a risk of the Fed not being able to rapidly and assertively act as a guard rail to dampen market volatility. This could result not only in financial contagion across the World, but likely absolute market paralysis, with unknowable consequences.”

Clearing houses are now more important than ever, the paper argued, with post-financial crisis regulation having forced more derivatives markets to clear with a central counterparty (CCP) like Chicago’s CME or LCH, owned by the LSE Group.

The paper continued: “The conventional belief that the shift to central clearing has made the financial system safer is misplaced. As any student of markets will tell you, financial risk can never be truly eliminated. It can be transformed and/or transferred, and Dodd-Frank/ EMIR simply transformed significant amounts of principal-to-principal credit risk, into CCP operational risk, as well as routinely ignored contingent market risk.”

Speaking at a conference last month, two clearing experts argued that, while the industry stood up to the test of extreme volatility and volumes in April this year, there are still issues with how different CCPs calculate margin, which can vary significantly from firm to firm.

Also at the conference, the co-director of HM Treasury’s Financial Services Group said the UK government is focusing this year on clearing as part of a broader programme of regulatory review.