Meet Me in the Middle – Central Clearing and Netting Efficiency in the Credit Default Swap Market

Abstract

We study the effect of central clearing on netting efficiency in the CDS market. We examine the development of position data and netting efficiency using aggregate data from the Depository Trust and Clearing Corporation (DTCC). Our main finding is that gross outstanding positions in cleared contracts increase, whereas net outstanding positions increase only at a marginally significant level. Hence, central clearing decreases netting efficiency to a considerable extent. Furthermore, we analyze different quintile portfolios of CDS contracts according to pre-clearing netting efficiency. We find that only those contracts that were most efficiently netted bilaterally, decrease in netting efficiency after the introduction of central clearing. The negative effect of central clearing on netting efficiency is more pronounced for the first contracts that have been made clearing eligible.

Keywords: Central clearing, credit default swaps, netting efficiency, counterparty risk

JEL Classification: G12, G15, G18, G23, G28