Cave quid optes: waterfalls and central counterparty capital

Robert T. Cox

Journal of Financial Market Infrastructures

Abstract: ABSTRACT With the heightened focus on the financial safeguards of central counterparties (CCPs), many market participants have called for greater CCPcapital contributions to so-called default waterfalls. Some have stressed the need for CCPs to be held to the same standards as other systemically important financial institutions (SIFIs). This paper examines the differences in the risk profiles of CCPs and banks, which constitute the majority of the SIFI population. We then examine the historical context of the role of CCP capital, the issues of the size and placement of CCP capital and the implications of the use of expensive CCP capital in the default waterfall. This is followed by an examination of the "Cover-2" standard of the Committee on Payments and Market Infrastructures/International Organization of Securities Commissions and a look at the possible uses of CCP capital in and around a terra incognita that lies at the end of the default waterfall. This paper ends with an examination of the action needed by key stakeholders to bring this "skin-in-the-game" argument to a close.

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