Governing Systemic Risk: Towards a Governance Structure for Derivatives Clearinghouses

Abstract:     
Derivatives transactions create systemic risk by threatening to spread the consequences of default throughout the financial system. Responding to the manifestations of systemic risk exhibited in the financial crisis, policy-makers have sought to solve the problem by requiring as many derivatives transactions as possible to be “cleared” (essentially guaranteed) by a clearinghouse. The clearinghouse will centralize and, through the creation of reserve accounts, seek to contain systemic risk by preventing the consequences of default from spreading. This centralization of risk makes the clearinghouse the new locus of systemic risk, and the question of systemic risk management thus becomes a question of clearinghouse governance. Unfortunately, each of the likely players in clearinghouse governance — dealers, customers, and investors — has significant incentive problems from the perspective of systemic risk management. I will argue that the policy-makers’ responses to these problems — focusing on voting caps and director independence — are inadequate to address the problem of systemic risk inherent in derivatives transactions. I argue, instead, in favor of the adoption of a new board structure more reflective of the public-private role of clearinghouses and suggest that models for this new governance structure can be found outside of traditional U.S. corporate governance norms in the dual-board structure of continental Europe.

Number of Pages in PDF File: 88

Keywords: derivatives, clearinghouse, Dodd-Frank, governance, financial regulation, systemic risk, counterparty credit risk, CFTC, SEC, DCO

JEL Classification: G28, K22, K23

Accepted Paper Series