Now a days Central Counterparties (CCPs) have a big impact in the financial market as managers of a complex web of counterparty risk. Therefore, CCPs are significant for CCPs themselves, their clearing members and the regulators who supervise them.
In this article I will focus not only on the risks in CCPs, but also and particularly on the risk of CCPs.
The growing importance of CCPs bring undeniable gain that bilateral arrangements could not do to the same degree. However, the growth of central clearing may also be followed by some unexpected side effects that need to be addressed.
BENEFITS OF CCPs
- Overcome information asymmetries. Especially in markets with a big number of heterogeneous players. CCPs ease the diligence efforts and risk management responsibilities that counterparties usually face by giving them the possibility to trade only with a single counterparty (the CCP)
- Application of latest risk management methods. This methods do not exist to the same extent in the bilateral world, which either relies on standardised margining methods that are not very risk-sensitive or on bank-internal margining models that may not necessarily meet the same high standards that CCPs are required to meet.
- Mutualise losses in a clear way. Which makes it easier for financial markets to handle huge losses and liquidity shortfalls that may occur in catastrophic events. CCPs can guide them to ensure that losses fall predictably on those who are more adequate to cope with them by carefully designing their risk management structure. Overall, CCPs introduces ex ante transparency and therefore certainty, provided that the rules are clear and well understood by market participants.
- Multilateral netting of exposures. A given level of risk protection can be achieved with a smaller amount of collateral, or vice versa, a given amount of collateral can achieve a higher level of risk protection.
DISADVANTAGES OF CCPs
- Risk concentration on CCPs. Nationally and internationally CCPs are progressively becoming institutions of unprecedented systemic interest. Their failure could lead to very serious systemic disruptions, therefore not only sound risk management, but also an effective recovery and resolution regime for CCPs is crucial.
- Banks relaying also in CCPs. Financial institution participating on CCPs need to understand the risk they face as members and take the necessary steps to reduce those risks.
- Creating dependency in the market. Crisis propagation may be further driven by interdependencies of changing complexity. These can exist between CCPs and other financial institutions, for example, through interoperability arrangements. The same large financial institutions, being clearing members of many CCPs, increase interdependencies even in the absence of interoperability.
- Cross-border friction. The use of an integrated infrastructure depends, sometimes, on exemptions from registration or the function of equivalence or substituted compliance with foreign infrastructures. Where foreign CCPs cannot be used, compliance with mandatory clearing under domestic laws may inhibit cross-border transactions.