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Undercapitalized clearinghouses may not withstand crisis, warns UniCredit boss

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Undercapitalized clearinghouses may not withstand crisis, warns UniCredit boss

Clearing houses, a key plank of the post-financial crisis architecture, are concentrating risk and are too undercapitalized to withstand a severe systemic shock, according to the CEO of Italy's largest bank.

A large bank failure could instantly wipe out the capital of a clearing house, because of the inevitable series of liquidations of positions related to the bank in question, UniCredit SpA CEO Jean Pierre Mustier told the FT Banking Summit in London. Such an event would likely bankrupt the clearing house, which might ultimately need emergency central bank cash to prevent default, he said.

"I think we need to look at what is the exact status of clearing houses," he said, estimating that the largest European clearing houses hold no more than roughly €600 million each against exposures orders of magnitude larger. They concentrate risks, especially for banks, which have become their largest counterparties, he said.

"Look at the business model of these entities and look at what would happen in a massive systemic shock. ... The business model is wrong," he said.

Clearing has become an object of contention in the negotiations over Britain's departure from the EU, with the European Central Bank suggesting that it may require large clearing houses such as London Stock Exchange Group Plc's LCH.Clearnet to book eurozone exposures within the bloc, rather than in London as is the case now.

"The clearing issue ... is not so much to do with Brexit. Clearing is a real problem from my perspective as a banker because my largest nominal exposure as a bank is with a clearing house. It's LCH on one side and it's Deutsche Börse AG's Eurex on the other side," said Mustier, who is a former board member of LCH.Clearnet, Europe's largest clearing house.

Central clearing of over-the-counter derivatives trades was made mandatory following a G-20 meeting in 2009, in an attempt to avoid a repeat of the situation that followed the bankruptcy of Lehman Brothers, when $500 billion of contracts had to be settled before they could cause further disruption to the global financial system.

But despite the best efforts of lawmakers, clearing houses themselves are concentrating substantial risk, and due to the mutual "major dependency" with banks, shocks could easily spread through to lenders, said the French executive.

As much as $7.7 trillion can be processed daily by a large European clearing house, as was the case with LCH.Clearnet in the week of Nov. 17, according to the Financial Times.