Central Counterparties (CCPs) and Systemic Risk

Abstract

The global financial infrastructure is a network of players and transactions. And a large set of transactions runs through a distinct number of financial players. A material part of these transactions is cleared through a central clearing party (CCP). Triggering uniformity of transactions, those CCPs also take out counterparty risk for its members. But a very material part of market transactions aren’t cleared and processed in the private market (over the counter [OTC]). The financial crisis documented that the counterparty risk can then be substantial, particularly in the derivatives markets. And so more transactions needed to be cleared was the regulator’s view. But that is not without complications. Besides the fact that the number of CCPs is limited and are now processing more transactions making them potentially systemically relevant, there are many open and problematic questions. How should they be regulated and supervised? What kind of balance sheet should they hold and should they be regulated like banks although they are not? What if one or more of their clients default? What does it mean for the CCP and its remaining clients? And which capital and other buffers should be built in? And what if the CCP itself defaults? How will members be protected? The choices made to answer these questions will be critical for the functioning of the industry and the stability of the entire financial system. But the jury is still out on many of them.