To Be or Not to Be? The Questionable Benefits of Mutual Clearing Agreements for Derivatives
62 Pages Posted: 25 Aug 2020 Last revised: 28 Aug 2020
Date Written: April 1, 2020
Recently, for standard asset classes, the first mutual clearing agreements between Central Coun- terparties (CCPs) have come into existence. There are already global concerns over the unique threats and benefits which arise from these situations, and further concern for an extension of agree- ments to derivatives CCPs. This paper applies the current mutual agreement framework to credit default swaps (derivatives) CCPs and compares this to clearing without any such agreement. Key results concern: The magnitude of price dispersion between multiple CCPs (as trading moves asset prices away from fundamental value), the magnitude of default contagion, the price impact of pre- dation, and the disciplinary mechanism inherent in the mutual cross-margin fund (between CCPs). Current regulatory debate, concerning the safety of permitting use of the default fund to meet inter-CCP shortfalls, is settled. Finally, a large-scale dynamic simulation models the price process – through variation margin exchange – and provides real-world policy/regulatory implications for a variety of market liquidity states.
Keywords: Mutual Agreement, Price Dispersion, Systemic Risk, CDS, Liquidation, Predation, Price Impact, Contagion, Financial Network, Over the Counter Markets
JEL Classification: G00, G01, G02, G14, G10, G18, G20, G23, G33
Suggested Citation: Suggested Citation