Abstract
This paper introduces a simple model of the default waterfall of a central counterparty (CCP) clearing service to provide an objective analysis of its composition. The three commonly found elements of the waterfall (initial margin, CCP capital at risk or “skin-in-the-game” (SITG), and default fund (DF)) are introduced, and the impact of varying the proportions of each element is discussed. The model suggests that, under reasonable assumptions, CCPs want SITG to be as low as possible, while clearing members prefer services where it plays a larger role in the default waterfall. In our setting, lower levels of SITG lead to a higher CCP return on equity but reduced levels of clearing. Moreover, CCPs have an incentive to keep initial margin higher than the required minimum, as this reduces the risk of DF losses without putting CCP capital at risk. The analysis presented suggests that a regulatory minimum requirement for SITG could play a role in incentivizing the use of CCPs where a clearing mandate does not apply and regulatory capital incentives to clear do not bite.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.