The New 'Too Big To Fail' - EU Proposes Taxpayer-Funded Derivatives System Bailout

It would appear the powers-that-be have just stumbled on to the ugly fact that all the bailed-in depositor money in the world won't stop the novated, rehypothecated, collateral chain collapse contagion that Deutsche Bank's $40 trillion-plus derivatives book's Damocles sword hangs over the status quo. However, being the problem-solving types, the European technocrats have a 'fair-share' solution - back a derivative clearing-house with taxpayer money to solve the new too-biggest-to-fail problem "that no one saw coming."

While the "rules" right nbow are that everyone from shareholders, bondholders, and depositors alike on up the capital structure are supposedly "bailed-in" to save an ailing bank, this problem is just way too big.

Here's the problem... in 3 charts...

Derivatives book - yuuge...


Global contagion - yuuger...


Counterparty risk - yuugest...


And so, as Bloomberg reports, the dear old European taxpayer is about to save the world... The European Union plans to give authorities sweeping powers to tackle ailing derivatives clearinghouses to prevent their failure from wreaking havoc throughout the financial system.

Draft EU legislation seen by Bloomberg sets out rules on saving or shuttering clearinghouses that would apply to firms such as London-based LCH. The proposals cover everything from the creation of resolution authorities to the powers they would have when winding a company down, including writing down shares, debt and collateral.


Having forced most clearing to go through central counterparties to manage risk in the financial system, the EU will come out with recovery and resolution proposals by year-end.  Clearing has come into focus after emerging as a pawn in the post-Brexit battle for London’s financial-services industry.


“If we are going to rely more on CCPs, we need to have a clear system in place to resolve them if things go wrong,” Valdis Dombrovskis, the EU’s financial-services chief, said last month.

Governments around the world were spooked by the damage inflicted by derivatives trades that went awry during the financial crisis. Since then, they’ve taken steps to ensure trading in the contracts is reported and centrally cleared.

Clearinghouses stand between the two sides of a derivative wager and hold collateral, known as margin, from both in case a member defaults.

The plan’s upfront costs for clearinghouses “are estimated to be in the millions for the largest institutions and in the thousands for smaller entities,” according to the summary of an EU impact study.


Costs for “better planning and prevention of failure” will vary by firms’ “size, interconnectedness, substitutability and complexity.”


While the process is taking risk out of the banking system, it has increased it in the clearinghouses, which might get into difficulty after the default of a clearing member -- typically a major bank -- or after some operational failure that inflicted major losses.


In both cases the authorities would need to act quickly and would be doing so amid a looming crisis.

And here is the kicker... guess who foots the bill when the fecal matter really strikes the rotating object...

“Should these options be unavailable or be demonstrably insufficient to safeguard financial stability, government participation in the shape of equity support or temporary public ownership could be considered as a last resort,” according to the proposal. Those steps would need to comply with EU rules on state aid.

So the US DoJ decision to retaliate for EU's Apple decision has boomerang'd right back at the EU taxpayer - who ultimately will bailout the new too-biggest-to-fail entities.

Italeave? Portugone? Fruckoff?