OTC central counterparty clearing: Myths and reality

Alistair Milne
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Alistair Milne: Professor of Financial Economics, Loughborough University, UK

Journal of Risk Management in Financial Institutions, 2012, vol. 5, issue 3, 335-346

Abstract: This paper discusses the costs and benefits of introducing central counterparty clearing (CCP) in ‘over-the-counter’ (OTC) derivative markets. It argues: (i) that the costs are not so large as some commentary has suggested, at least provided that mandatory clearing is applied only to widely traded standardised contracts; (ii) that the key economic benefits of having CCP clearing do not come from reduction of counterparty credit risk (firms are perfectly capable of doing this on their own) — it is instead improved oversight of market participants and the coordinated management of open positions following the failure of a systemically important financial institution, ie the management of default in a systemic crisis; (iii) because these benefits are public goods some policy intervention is appropriate to encourage a suitable level of adoption of CCP clearing; and finally (iv) that the ‘rule based’ approach to CCP clearing of OTC contracts required by Dodd–Frank has become diverted into an inappropriate focus on the precise requirements for mandatory clearing. Instead a more flexible approach can achieve an appropriate balance between reduced systemic financial risk and the compliance burden on firms.

Keywords: counterparty risk; central counterparties; systemic financial risk; financial stability; OTC derivatives; financial regulation (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2012:v:5:i:3:p:335-346

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