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Journal of Financial Intermediation Vol. 32 2017

Does OTC derivatives reform incentivize central clearing?

Samim Ghamami1,2,3,4; Paul Glasserman5

1 United States Department of the Treasury · 2 Courant Institute of Mathematical Sciences · 3 New York University · 4 University of California, Berkeley · 5 Columbia University

Abstract

Regulatory changes in the over-the-counter (OTC) derivatives market seek to reduce systemic risk. The reforms require that standardized derivatives be cleared through central counterparties (CCPs), and they set higher capital and margin requirements for non-centrally cleared derivatives. We investigate whether these requirements create a cost incentive in favor of central clearing, as intended. We compare the total capital and collateral costs when banks transact fully bilaterally and when they clear all contracts through CCPs. We calibrate our model using data on the OTC market collected by the Federal Reserve. We find that the cost incentive may not favor central clearing. The main factors driving the cost comparison are netting benefits, the margin period of risk, and CCP guarantee fund requirements. Lower guarantee fund requirements lower the cost of clearing but make CCPs less resilient.

DOI
10.1016/j.jfi.2017.05.007
Volume
32
Pages
76-87
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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