Five Fundamental Questions on Central Counterparties

Abstract

Central counterparties (CCPs) are designed to reduce aggregate counterparty credit risk and
function as market infrastructures for capital markets in securities and derivatives. Although CCPs, also known as clearing houses, exist for well over a century, they have gained prominence since they became the main international public policy response to the Lehman crisis of making over-the-counter derivative transactions safer. This G20's response to the Lehman crisis of making central clearing mandatory for standardized over-the-counter derivative transactions has been translated into law, Dodd-Frank for the US and EMIR for the EU. However, CCPs remain to some extent controversial with adversaries claiming that they potentially increase systemic risk and proponents viewing them as systemic risk reducing when properly designed and maintained. In this article I review the booming literature on CCPs, of which about 60% is published in the last five years, by asking five fundamental questions about CCPs. The aim is to construct a broad, academically substantiated, synthesis about CCPs and to propose directions for future research in what can be considered as the most important niche of financial economics.

Keywords: Central Counterparty, Clearing, OTC Derivatives, Financial Stability, G20 Central Clearing Mandate, Recovery and Resolution

JEL Classification: G01, G23, G28