Does OTC Derivatives Reform Incentivize Central Clearing?

47 Pages Posted: 11 Aug 2016  

Samim Ghamami

Office of Financial Research, US Department of the Treasury; University of California, Berkeley - Center for Risk Management Research

Paul Glasserman

Columbia Business School

Multiple version iconThere are 2 versions of this paper

Date Written: August 7, 2016

Abstract

The reform program for the over-the-counter (OTC) derivatives market launched by the G-20 nations in 2009 seeks to reduce systemic risk from OTC derivatives. The reforms require that standardized OTC derivatives be cleared through central counterparties (CCPs), and they set higher capital and margin requirements for non-centrally cleared derivatives. Our objective is to gauge whether the higher capital and margin requirements adopted for bilateral contracts create a cost incentive in favor of central clearing, as intended. We introduce a model of OTC clearing to compare the total capital and collateral costs when banks transact fully bilaterally versus the capital and collateral costs when banks clear fully through CCPs. Our model and its calibration scheme are designed to use data collected by the Federal Reserve System on OTC derivatives at large bank holding companies. We find that the main factors driving the cost comparison are (i) the netting benefits achieved through bilateral and central clearing; (ii) the margin period of risk used to set initial margin and capital requirements; and (iii) the level of CCP guarantee fund requirements. Our results show that the cost comparison does not necessarily favor central clearing and, when it does, the incentive may be driven by questionable differences in CCPs’ default waterfall resources. We also discuss the broader implications of these tradeoffs for OTC derivatives reform.

Keywords: Central Clearing, OTC Derivatives, Margin, Collateral, Capital

JEL Classification: G01, G18, G20, G28

Suggested Citation

Ghamami, Samim and Glasserman, Paul, Does OTC Derivatives Reform Incentivize Central Clearing? (August 7, 2016). Columbia Business School Research Paper No. 16-53. Available at SSRN: https://ssrn.com/abstract=2819714 or http://dx.doi.org/10.2139/ssrn.2819714

Samim Ghamami (Contact Author)

Office of Financial Research, US Department of the Treasury ( email )

717 14th Street, NW
Washington, DC 20220
United States

University of California, Berkeley - Center for Risk Management Research ( email )

581 Evans Hall
Berkely, CA 94720
United States

Paul Glasserman

Columbia Business School ( email )

3022 Broadway
403 Uris Hall
New York, NY 10027
United States
212-854-4102 (Phone)
212-316-9180 (Fax)

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