Central Counterparties (CCPs) are systemic nodes in financial markets. Incentive regulation on CCPs becomes crucial for financial stability. I investigate incentives and optimal regulation of a profit-driven CCP with limited liability. Conditional on available capital, the CCP fine-tunes collateral requirements to balance fee incomes against counterparty risk. High collateral reduces potential default losses, but leads to foregone profitable trades. Limited liability creates a wedge between the CCP’s collateral policy and the socially optimal solution to this trade-off. However, regulators can use capital requirements to close the wedge, unless clearing fee exceeds a threshold.
Systemic Risk in Real Time: A Risk Dashboard for Central Clearing Parties (CCPs) with Albert J. Menkveld
Time is valuable, in particular in stressed markets. As central clearing parties (CCPs) have become systemically important institutions, it is desirable to track their exposure towards clearing members in real time. We propose a risk dashboard that not only tracks such exposure, but also offers a decomposition. This enables a CCP to be alerted by sudden large increases, but also to identify their root causes. When implementing the approach on real world data we find fat tails. Zooming in on extreme increases, we find that they are dispro- portionately due to crowded trades among intermediaries --- desirable if motivated by hedging, worrying if due to speculation.