Risk Mutualization in Central Clearing: An Answer to the Cross-Guarantee Phenomenon from the Financial Stability Viewpoint

Melinda Friesz, Kira Muratov-Szabó, Andrea Prepuk and Kata Váradi
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Melinda Friesz: KELER Ltd., 1074 Budapest, Hungary
Kira Muratov-Szabó: KELER CCP Ltd., 1074 Budapest, Hungary
Andrea Prepuk: MVM CEEnergy Ltd., 1138 Budapest, Hungary
Kata Váradi: Department of Finance, Corvinus University of Budapest, 1093 Budapest, Hungary

Risks, 2021, vol. 9, issue 8, 1-19

Abstract: Central counterparties’ (CCPs) role is to take over the counterparty risk during trading. To fulfill its role, a CCP needs to operate a multi-level guarantee system that can absorb losses of clearing members’ defaults. Our main question is how the size of the guarantee system changes and how the cross-guarantee undertaking changes between clearing members and markets if the CCP merges the guarantee systems of different markets. This question is essential from a financial stability perspective since the size and the structure of the guarantee system will affect the loss-absorbing capacity of a CCP. We used Monte Carlo simulation to simulate a 30 year time-series for three different products, which gave us the basis for the value-at-risk-based margin calculation and the stress-test-based default fund calculation. Results show that merging the guarantee systems will always decrease the total value of the guarantees because the margin will decrease, which cannot be offset by the increase in the default fund size. We conclude that it is not optimal from the financial stability perspective to merge the guarantee systems. However, if the CCP wants to provide cheaper services, or if the clearing members are willing to cross-guarantee each other, merging is more suitable.

Keywords: initial margin; default fund; central counterparty; stress test (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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