Market liquidity, closeout procedures and initial margin for CCPs

Fernando Cerezetti (), Anannit Sumawong (), Emmanouil Karimalis and Ujwal Shreyas
Additional contact information
Fernando Cerezetti: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Anannit Sumawong: University of Sussex

No 643, Bank of England working papers from Bank of England

Abstract: Closeout procedures enable central counterparties (CCPs) to respond to events that challenge the continuity of their normal operations, most frequently triggered by the default of one or more clearing members. The procedures ensure the regularity of the settlement process through the prudent and orderly closeout of the defaulter’s portfolio. Traditional approaches to CCPs’ margin requirements typically assume a simple closeout profile, and do not account for the ‘real-life’ constraints embedded on the management of a default. The paper proposes an approach of evaluating how distinct closeout strategies may expose a CCP to different sets of risk and costs, and consequently could impact the sufficiency of financial resources to cover its risk exposure to a default. The approach is based on a counterfactual simulation, and evaluates a full spectrum of hedging strategies in an exploratory and model-free manner, deriving endogenous and market-dependent risk metrics. Using the trade repository data available to the Bank (as a result of EMIR reporting) on over-the-counter (OTC) interest rate swaps (IRS) and ten years (ie 2005 to 2015) of information on related market risk factors, the paper derives empirically an efficient hedging strategy that minimizes the CCP’s risk exposure to a defaulting clearing member. Endogenous trade-off structures between total risk (market risk plus funding needs) and transaction costs are also established, with marginal sensitivities to individual components of the hedging strategy determined.

Keywords: CCPs; market liquidity; closeout procedures; initial margin (search for similar items in EconPapers)
JEL-codes: C61 G20 G28 G32 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2017-02-06
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Market liquidity, closeout procedures and initial margin for CCPs (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0643

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