The Failure of a Clearinghouse: Empirical Evidence
71 Pages Posted: 2 Nov 2016 Last revised: 28 Aug 2018
Date Written: August 25, 2018
How can we design safe financial institutions, and how should we efficiently resolve them? We study these questions by empirically analyzing the failure of a derivatives central clearing counterparty (CCP) in Paris in 1974. First, we identify the risk management failures that caused the default and draw implications for CCP design. Second, we show evidence of new agency problems arising when supervisors have discretionary powers over debt restructuring for a failed entity. These conflicts, between managers and the supervisor (misreporting), as well as between managers and creditors (risk-shifting), are difficult to mitigate with regulation or covenants. Their existence has implications for the design of recovery and resolution rules for financial institutions.
Keywords: Central Clearing; Failure; Risk Management; CCP; Collateral; Derivatives
JEL Classification: G23
Suggested Citation: Suggested Citation