The Dilemma of a Central Counterparty versus a Qualified Central Counterparty in a Developing Country

Abstract

The Basel Committee on Banking Supervision (BCBS) has a policy framework for how clearing member banks should treat their exposures to central counterparties (CCPs). Default funds play a crucial role as a risk mitigant in this framework. Furthermore, the Committee on Payment and Settlement Systems and Technical Committee of the International Organization of Securities Commissions (together abbreviated as CPSS-IOSCO) produced a set of 26 principles for financial market infrastructures. For a CCP to be deemed a qualified CCP, it has to abide by these principles. Clearing member banks with trade exposures to a qualified CCP will get preferential capital treatment under the BCBS framework. None of the principles or the policy framework requires, or forces a CCP to have a default fund. However, regulators prefer CCPs to have default funds in place to enhance their credit risk management practices, as required by principles 4 and 6 of the CPSS-IOSCO, before they will be qualified. We consider the merits of the BCBS's requirements for a clearing house, in a developing country such as South Africa, to become a qualified clearing house and conclude that a CCP with prudent risk management processes and controls, should not be disqualified if a default fund is not established.