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Basic Principles of Central Clearing

5 important questions on Basic Principles of Central Clearing

What about multilateral offset?

A major problem with bilateral clearing is the proliferation of overlapping and potentially redundant contracts, which increases counterparty risk and adds to the interconnectedness of the financial system. Netting is important and benefical by CCP as bilaterally they might be not identical. So:
- Multilateral offset
- No knock out effect

What about loss mutualisation?

Defaulter pays approach is hard to establish. Basically cover losses to a high level of confidence. Members all contribute to a default fund to absorb extreme losses mutually. Even if no positions or all netted, it still has a share in the default fund.

Problems: moral hazard and adverse selection

Number of OTC CCP?

Large number will maximize competition but lead to a run to much more risky CCP landscape. Usually spread:
- Regionally
- Product
Interoperability between CCPs, but is will increase interconnectedness which might increase systemic risk. CCPs should be profit-making to attract high-class people to value trades

Can a CCP fail?

Yes and that would be much worse. Should have loss allocation methods to absorb losses that doesn't create systemic market disturbance. Use central bank as lender of last resort.

What is the impact of central clearing?

Reduce systemic risk? By greater transparency? Yes, might be a signal. But also potential to increase it by increasing margins in turbulent times. Really effective in risk mitigation? Mandatory clearing might have adverse effects...