Global regulators proposed tougher standards for clearinghousesat the heart of the US$493 trillion derivatives market, taking someof the biggest steps yet to prevent the platforms from becoming toobig to fail.

The Financial Stability Board (FSB) and other securitiesregulators published guidelines on Tuesday for clearinghouses tobolster their assessments of risks and improve plans for how they'drecover after the default of major bank members. Therecommendations came after regulators found some clearinghousesnegligent in complying with existing standards.

The Basel-based FSB, whose members include the Bank of Englandand U.S. Federal Reserve, also began to lay out how regulatorscould resolve a clearinghouse if its own recovery plan fails.

“Although the risk of default cannot be entirely eliminated fromthe global financial system, we aim to limit potential systemicrisks arising from any default by a central counterparty member asmuch as possible by applying a robust but balanced approach toreinforce financial buffers and risk control,” Ashley Alder, boardchair of the International Organization of Securities Commissions,said in a statement.

Derivatives Clearinghouses Come Under Greater Scrutiny

In the aftermath of the 2008 financial crisis, regulators aroundthe world mandated that more derivatives be settled atclearinghouses that collect collateral from buyers and sellers tolimit the risk to the system from a trader's default. Manytransactions were previously conducted directly between traderswithout a third party requiring collateral. Swaps trading—when itwas largely unregulated—amplified the meltdown and prompted a $182billion U.S. rescue of American International Group Inc.

As a result of regulators' post-crisis rules, clearinghousesoperated by the London Stock Exchange Group Plc, CME Group Inc.,and Intercontinental Exchange Inc. have grown in importance. Thathas led to calls from regulators, as well as from JPMorgan Chase& Co., BlackRock Inc., and other large traders, for greaterscrutiny of the companies.

To protect against defaults, banks deposit collateral atclearinghouses, which also contribute some of their own capital. Ifboth of these funding sources are exhausted in a time of stress, aclearinghouse could then require banks and other members to pick upthe tab.

“It is clear to us that the risk of default cannot be eliminatedfrom the global financial system—to do so would imply unsustainablecosts and severely restrict or even prevent businesses from usingderivatives to manage commercial and financial uncertainty,” Alderand Benoit Coeure, chair of the Committee on Payments and MarketInfrastructures, said in an op-ed first published in the FinancialTimes. “So the aim is to limit the potential systemic risks arisingfrom any default as much as possible by encouraging centralclearing and then applying a robust but proportionate approach toback up financial buffers and risk control.”

In a 160-page report assessing current oversight, securitiesregulators said clearinghouses have made “meaningful progress” tocomply with standards put in place since 2008. Still, they found“gaps and shortcomings” and said some clearinghouses haven't yetfully put in place recovery plans required by regulators.

“These CCPs, and their supervisors, regulators, and overseers,should consider this to be a serious issue of concern that shouldbe addressed with the highest priority,” according to the reportfrom IOSCO and the Committee on Payments and MarketInfrastructures.

Where CCPs Are Falling Short

The report, which reviewed 10 clearinghouses in ninejurisdictions, found that some have failed to put in place policiesto ensure they have sufficient financial resources and lack robusttests of their liquidity. Regulators said they expect the firms tofix the problems by the end of the year, though they didn'tdisclose which clearinghouses were at fault. The report relied ondata as of June 30, 2015.

The organizations proposed additional guidance forclearinghouses' credit and liquidity resource requirements, margin,contribution of own financial resources to losses, and recoveryplans. The guidelines suggest that clearinghouses' recovery plansshould have a clear description of arrangements to obtainadditional liquidity, such as cash or pre-arranged funds, in theevent of a crisis.

“It's crucial that CCPs put in place clear, transparent, andcomprehensive recovery plans that disclose the steps a CCP wouldtake if its default resources are exhausted,” Scott O'Malia, chiefexecutive of the International Swaps and Derivatives Association,said in a statement. ISDA's membership includes Citigroup Inc.,JPMorgan, and Deutsche Bank AG, among other large swapsdealers.

In addition, the authorities have started work on a commonsystem for supervisors to stress-test clearinghouses. The reportstopped short of providing guidance to clearinghouses on how theyshould determine members' financial contributions to funds that canbe tapped in the event of a default.

The FSB, which under BOE Governor Mark Carney has made oversightof clearinghouses a top priority, also published a paper on Tuesdayseeking industry feedback on how authorities might step in tooversee a failing firm if the recovery process isn't working. Theeffort is meant to ensure clearinghouses can be resolved withouttaxpayer-funded bailouts or losses spreading throughout thefinancial system.

“CCPs form a central part of the post-crisis reforms of OTCderivatives markets to help reduce risk in the financial system,”Elke Koenig, chair of the FSB's resolution steering group and headof the European Single Resolution Board, said in a statement,referring to central counterparties. “But we must also ensure thatCCPs are themselves robust and this includes appropriate resolutionregimes.”

The paper, open for comment until October 17, asks for feedbackon criteria regulators should use to determine when to step in toresolve a firm, whether clearinghouses should have additional fundsavailable for resolution, and how losses should be allocated amongdefaulting and non-defaulting members. The FSB said it will proposemore specific guidance on resolution early next year, which itplans to complete later in 2017.

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