Central counterparty links and clearing system exposures

Cox, Nathanael; Garvin, Nicholas; Kelly, Gerard

doi:10.21314/jfmi.2014.026

Cited by 4 publications

(2 citation statements)

References 5 publications

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“…They then use a computational approach to compare the effect of various clearing arrangements on expected netted exposures. Anderson, Dion, and Pérez Saiz (2013) and Cox, Garvin, and Kelly (2013) apply the Duffie and Zhu framework to explore the policy issue of interoperability between CCPs. They examine whether a regulator can reduce expected netted exposures by mandating trades to be novated to a local CCP, which can link to a global CCP that clears a range of products.…”

Section: A Review Of the Relevant Literaturementioning

confidence: 99%

Centralized netting in financial networks

Garratt

Zimmerman

2020

Journal of Banking & Finance

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We consider how the introduction of centralized netting in financial networks affects total netted exposures between counterparties. In some cases there is a trade-off: centralized netting increases the expectation of net exposures, but reduces the variance. We show that the set of networks for which expected net exposures decreases is a strict subset of those for which the variance decreases, so the trade-off can only be in one direction. For some network structures, introducing centralized netting is never beneficial to dealers unless sufficient weight is placed on reductions in variance.This may explain why, in the absence of regulation, traders in a derivatives network do not develop central clearing. Our results can be used to estimate margin requirements and counterparty risk in financial networks.

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Section: A Review Of the Relevant Literaturementioning

confidence: 99%

Centralized netting in financial networks

Garratt

Zimmerman

2020

Journal of Banking & Finance

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show abstract

“…They then use a computational approach to compare the efficiency of various clearing arrangements. Anderson, Dion and Pérez Saiz (2013) and Cox, Garvin and Kelly (2013) apply the Duffie and Zhu framework to explore the policy issue of interoperability between CCPs. They use the model to examine whether a regulator can reduce netted exposures by mandating trades to be novated to a local CCP, which can link to a global CCP that clears a range of products.…”

Section: Introductionmentioning

confidence: 99%

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Garratt

Zimmerman

2015

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractNovating a single asset class to a central counterparty (CCP) in an over-the-counter derivatives trading network impacts both the mean and variance of total net exposures between counterparties. When a small number of dealers trade in a relatively large number of asset classes, central clearing increases the mean and variance of net exposures, which may lead to increased counterparty risk and higher margin needs. There are intermediate cases where there is a tradeoff: The introduction of a CCP leads to an increase in expected net exposures but this increase is accompanied by a reduction in variance. We extend the work of Duffie and Zhu (2011) by considering general classes of network structures and focus on scale-free and core-periphery structures, which have been shown to be accurate models of real-world financial networks. We find that a CCP is unlikely to be beneficial when the link structure of the network relies on just a few key nodes. In particular, in large scale-free networks a CCP will always worsen expected netting efficiency. In such cases, CCPs can improve netting efficiency only if agents have some degree of risk aversion that allows them to trade off the reduced variance against the higher expected netted exposures. This may explain why, in the absence of regulation, traders in a derivatives network may not develop a CCP themselves.

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Clearing and Collateral Mandates: A New Liquidity Trap?

Pirrong

2012

J Applied Corp Finance

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All too often, legislative solutions to some financial crisis have serious consequences that are both unwanted and unintended. The author of this article foresees several possible negative consequences arising from Title VII of the Dodd‐Frank Act, which mandates that eligible derivatives be cleared through central counterparties (CCPs) that require initial and variation margin. The new legislation also requires that the remaining non‐cleared derivatives that are traded by some market participants be more heavily collateralized. The Act's authors have argued that derivatives pose uniquely dangerous systemic risks because of the leverage and counterparty risk associated with them. Increased collateralization, their thinking goes, would reduce derivatives‐related leverage and the systemic risk to the financial system associated with such leverage. The author argues that these hopes are unduly optimistic because they fail to recognize how market participants can substitute other forms of leverage, such as bank lines of credit or collateral transformation trades, for the leverage derivatives provided previously. The author also believes that the larger collateral mandates and frequent marking‐to‐market will make the financial system more vulnerable since margin requirements tend to be “pro‐cyclical.” And more rigid collateralization mechanisms can restrict the supply of funding liquidity, and lead to spikes in funding liquidity demand that can reduce the liquidity of traded instruments and generate destabilizing feedback loops. The fragmentation of CCPs across jurisdictions and products will lead to greater demand for CCP‐eligible collateral to maintain the same level of hedging transactions. This demand will likely be met by using riskier assets as collateral and encourage the shadow banking system to create new assets that can be posted as collateral (for example, via collateral transformation services). In sum, although the Dodd‐Frank rules are intended to reduce systemic risk, their expected impact on liquidity makes it a very open question as to whether they will achieve this goal. Although they may reduce some risks, they will simply shift others while possibly creating new ones.

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Central counterparty links and clearing system exposures

Cited by 4 publications

References 5 publications

Centralized netting in financial networks

Centralized netting in financial networks

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Clearing and Collateral Mandates: A New Liquidity Trap?

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