Central clearing counterparties: benefits, costs and risks

Abstract

Since the international financial crisis, central clearing counterparties (CCPs) have assumed a key role in the over-the-counter (OTC) derivatives market. One of the factors behind this increase in activity is the G20 requirement to centrally clear standardised OTC derivatives. This initiative rests on the belief that centralised clearing can help reduce counterparty risk, and the systemic risk associated with OTC derivatives markets. But risk concentration in CCPs (chiefly counterparty risk), potential loss mutualisation in the event of one or more clearing members defaulting and the high interdependencies with the rest of the financial system entail significant consequences for financial stability. Hence international agencies, such as the Financial Stability Board (FSB) and the European Commission and other regulators, are working on initiatives to strengthen their soundness and the capacity for recovery and resolution in the event of crisis. From the banking perspective, the analysis of these entities is significant insofar as a big portion of clearing members are banks. Accordingly, any tool aimed at ensuring the continuity of the CCP will have a direct effect on them. This article analyses the functions of a CCP, its risks and the tools available for facing losses given the role that banks play in centralised clearing.