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European central bankers this week began testing how a bank default would pressure certain trade-plumbing firms, the latest sign of concern over the clearinghouses that aim to limit markets' vulnerability to the damaging fire sales that characterized the 2008 crisis.

Stress-testing clearinghouses, alongside a related discussion of the terms of any public assistance they may receive in a pinch, are issues at the top of the agenda for many regulators, bankers and investors, following the adoption of postcrisis rules that placed these safety nets at the center of financial-system overhauls. Which conditions might merit public financial assistance is an issue that the Federal Reserve hasn't taken a public position on.

The Bank of England along with Germany's Bundesbank and Federal Financial Supervisory Authority, or BaFin, on Tuesday started to simulate a hypothetical default by a bank at both the SwapClear unit of London Stock Exchange Group PLC's LCH.Clearnet Group Ltd. and Deutsche Bö rse AG's Eurex Clearing, said people familiar with the test.

The effort comes as investor nervousness about the health of big banks is on fresh display, with shares of large banks down significantly this year on both sides of the Atlantic, amid slowing global growth and falling interest rates. Barclays PLC's London-listed shares were down 21% this year at midday Thursday, and Deutsche Bank AG's Frankfurt-listed shares were down 33%.

The exercise is the first example of concurrent stress tests at two clearinghouses, the people familiar with the event said, and the first of its kind to be initiated by central banks. Existing rules dictate the companies must run their own routine stress tests on an individual basis at least once a year.

Clearinghouses such as LCH and Eurex are supposed to help prevent a marketwide collapse by ensuring trading partners get paid even if one defaults. In a 2009 regulatory pact, leaders of the Group of 20 nations agreed to process hundreds of trillions of dollars of derivatives through clearinghouses.

Now, analysts are concerned the expanded use of clearinghouses could magnify the effects of the next crisis. Central bankers have moved to fortify clearinghouses, taking lessons from bank stress tests, without committing explicit financial support in advance to avoid creating a "moral hazard" that analysts warn could cause excessive risk-taking by clearinghouses. When a clearinghouse runs into trouble, a primary line of defense is capital from its member banks.

In the U.S., the question of when the Fed would assist an ailing clearinghouse is murky and politically charged following the 2008 taxpayer bailout of American International Group Inc.

Wall Street would like clearinghouses to have liquidity from the U.S. central bank so long as the firms remain solvent, according to Thomas Kloet, a former chief executive of exchange operator TMX Group Ltd. and chairman of a subcommittee within the market risk advisory group at the Commodity Futures Trading Commission.

Emily Portney, a clearing executive with J.P. Morgan Chase & Co., said at a CFTC committee meeting last year that the reason banks and other participants are aligned on the issue is because without dedicated central-bank support "you're actively allocating liquidity out to banks at the worst possible time."

Last year, the European Central Bank and the Bank of England announced new measures to enhance the liquidity and stability of clearinghouses, but said they were extending facilities called existing swap lines to the firms "without pre-committing to the provision of liquidity."

In the U.S., the Fed hasn't publicly stated how and when it would provide liquidity to clearinghouses in stressed periods. The central bank has authority under the 2010 Dodd-Frank financial-overhaul law to offer clearinghouses borrowing privileges "only in unusual or exigent circumstances" so long as certain requirements are met and firms have tried to borrow privately.

Still, there remains a concern that such assistance could be viewed as tantamount to a government backstop.

In a November speech, Fed governor Jerome Powell said, "By design, increased central clearing will concentrate risks in [clearinghouses]; it is essential that, as these risks accumulate, [they] build up their ability to manage them."

Last year, regulators at the Fed and the Securities and Exchange Commission started pushing a large U.S. repo clearinghouse to shore up its finances with a new $50 billion credit facility provided by its member banks or other institutions, but met resistance from smaller industry participants who complained they would have to leave the market.

Next Wednesday, policy makers and central bankers, including Fed Vice Chairman Stanley Fischer, will gather in Washington for a conference about last-resort lending organized by the Committee on Capital Markets Regulation.

Hal Scott, Nomura professor of international financial systems at Harvard Law School, said when comparing all last-resort lending powers across Europe, the U.K., Japan and the U.S., the Fed has "the weakest of the four," in part because of new restrictions placed in the postcrisis Dodd-Frank law.

Any expansion of the Fed's lending authority to clearinghouses "could have much harsher implications for the next financial crisis than anything they have done in the banking or the securities industries," said Norbert Michel, a research fellow in financial regulation at the Heritage Foundation, a conservative think tank.

AIG had fully repaid the bailout by the end of 2012 and the government made a $22.7 billion profit. But last year, a court ruled the government exceeded its authority in completing the 2008 rescue.

At the CFTC hearing last November, Kevin McClear, an executive at clearinghouse and exchange operator Intercontinental Exchange Inc., said, "We think the best source to get Treasury liquidity would be the Fed. We don't want to borrow money, but we think we should have access to the discount window…only during times of stress, not as business as usual."

Write to Katy Burne at katy.burne@wsj.com

(END) Dow Jones Newswires

February 04, 2016 16:35 ET (21:35 GMT)

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