Clearinghouses as Liquidity Partitioning
Fordham University School of Law
October 12, 2013
Cornell Law Review, Forthcoming
This Article identifies a key economic benefit of derivatives clearinghouses that is not recognized by previous scholarship: faster payouts to creditors when a trading firm fails. By increasing opportunities to set off a failed firm’s debts, a clearinghouse provides immediate payouts to creditors who otherwise would have to wait for slower bankruptcy payouts. The Article shows how quicker payouts through clearinghouses reduce illiquidity and uncertainty, two sources of systemic risk. Through setoffs, a clearinghouse can reduce systemic risk even if the clearinghouse is itself insolvent. Unlike the benefits of clearinghouses claimed by prior scholarship, faster payouts are not zero-sum in their impact on creditors: besides accelerating payouts to members, a clearinghouse eases the administrative burden on the failed member’s bankruptcy trustee or receiver, permitting quicker payouts to non-clearinghouse creditors as well. By identifying faster payouts as the main systemic benefit of clearinghouses, this Article identifies an unappreciated complementarity between the Dodd-Frank Act’s clearing mandate, which requires central clearing of swap contracts, and the statute’s “orderly liquidation authority” for resolving failed financial firms. The clearing mandate will reduce the need for the liquidation authority to be invoked, and when the authority is nonetheless invoked the mandate will simplify the FDIC’s duties as receiver.
Number of Pages in PDF File: 51
Keywords: clearinghouse, bankruptcy, systemic risk, liquidity, orderly liquidation authority, asset partitioning, netting, setoff, Dodd-Frank
JEL Classification: G21, G28, G33, G38, K20Accepted Paper Series
Date posted: December 5, 2012 ; Last revised: October 28, 2013
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