1932

Abstract

Central clearing counterparties (CCPs) have a variety of economic rationales. The Great Recession of 2007–2009 led regulators to mandate CCPs for most interest-rate and credit derivatives, markets in which large amounts of risks are transferred across agents. This change led to a large increase in CCP studies, which along with classical studies are surveyed in this article. For example, multilateral netting, the insurance against counterparty risk, the effect of CCPs on asset prices and fire sales, margins setting, the default waterfall, and CCP governance are discussed here. We review both CCP theory and empirical work and conclude by discussing regulatory issues.

Loading

Article metrics loading...

/content/journals/10.1146/annurev-financial-100520-100321
2021-11-01
2024-12-06
Loading full text...

Full text loading...

/deliver/fulltext/financial/13/1/annurev-financial-100520-100321.html?itemId=/content/journals/10.1146/annurev-financial-100520-100321&mimeType=html&fmt=ahah

Literature Cited

  1. Acharya V, Bisin A. 2014. Counterparty risk externality: centralized versus over-the-counter markets. J. Econ. Theory 149:153–82
    [Google Scholar]
  2. Adrian T, Brunnermeier MK 2016. CoVaR. Am. Econ. Rev. 106:1705–41
    [Google Scholar]
  3. Aggarwal R. 2002. Demutualization and corporate governance of stock exchanges. J. Appl. Corp. Finance 15:105–13
    [Google Scholar]
  4. Aggarwal R, Dahiya S. 2006. Demutualization and public offerings of financial exchanges. J. Appl. Corp. Finance 18:96–106
    [Google Scholar]
  5. Akerlof GA. 1970. The market for “lemons”: quality uncertainty and the market mechanism. Q. J. Econ. 84:488–500
    [Google Scholar]
  6. Amini H, Filipović D, Minca A. 2016. To fully net or not to net: adverse effects of partial multilateral netting. Oper. Res. 64:1135–42
    [Google Scholar]
  7. Amini H, Filipović D, Minca A. 2017. Systemic risk and central clearing counterparty design SSRN Work. Pap. 13-34
    [Google Scholar]
  8. Amini H, Filipović D, Minca A. 2020. Systemic risk in networks with a central node. SIAM J. Financ. Math. 11:60–98
    [Google Scholar]
  9. Amini H, Minca A. 2020. Clearing financial networks: impact on equilibrium asset prices and seniority of claims. Tutorials Oper. Res. Nov.:15475
    [Google Scholar]
  10. Andersen L, Duffie D, Song Y 2019. Funding value adjustments. J. Finance 74:145–92
    [Google Scholar]
  11. Antinolfi G, Carapella F, Carli F 2019. Transparency and collateral: the design of CCPs' loss allocation rules Finance Econ. Discuss. Ser. 2019-058 Board Gov., Fed. Reserve Syst. Washington, DC: https://doi.org/10.17016/FEDS.2019.058
    [Crossref] [Google Scholar]
  12. Ashcraft AB. 2005. Are banks really special? New evidence from the FDIC-induced failure of healthy banks. Am. Econ. Rev. 95:1712–30
    [Google Scholar]
  13. Baer HL, France VG, Moser JT. 2004. Opportunity cost and prudentiality: an analysis of collateral decisions in bilateral and multilateral settings. Res. Finance 21:201–27
    [Google Scholar]
  14. Bell S, Holden H. 2018. Two defaults at CCPs, 10 years apart. BIS Q. Rev. Dec:75
    [Google Scholar]
  15. Benoit S, Colliard JE, Hurlin C, Pérignon C. 2017. Where the risks lie: a survey on systemic risk. Rev. Finance 21:109–52
    [Google Scholar]
  16. Benos E, Huang W, Menkveld AJ, Vasios M. 2019. The cost of clearing fragmentation Staff Work. Pap. 800, Bank Engl London:
    [Google Scholar]
  17. Benos E, Payne R, Vasios M. 2020. Centralized trading, transparency, and interest rate swap market liquidity: evidence from the implementation of the Dodd-Frank Act. J. Financ. Quant. Anal. 55:159–92
    [Google Scholar]
  18. Bernanke B. 1990. Clearing and settlement during the crash. Rev. Financ. Stud. 3:133–51
    [Google Scholar]
  19. Bernstein A, Hughson E, Weidenmier M. 2019. Counterparty risk and the establishment of the New York Stock Exchange clearinghouse. J. Political Econ. 127:689–729
    [Google Scholar]
  20. Bester H. 1987. The role of collateral in credit markets with imperfect information. Eur. Econ. Rev. 31:887–99
    [Google Scholar]
  21. Biais B, Heider F, Hoerova M. 2012. Clearing, counterparty risk and aggregate risk. IMF Econ. Rev. 60:193–222
    [Google Scholar]
  22. Biais B, Heider F, Hoerova M. 2016. Risk-sharing or risk-taking? Counterparty risk, incentives and margins. J. Finance 71:1669–98
    [Google Scholar]
  23. Biais B, Heider F, Hoerova M. 2020. Variation margins, fire sales, and information-constrained optimality. Rev. Econ. Stud In press. https://doi.org/10.1093/restud/rdaa083
    [Crossref] [Google Scholar]
  24. Bignon V, Vuillemey G. 2020. The failure of a clearinghouse: empirical evidence. Rev. Finance 24:99–128
    [Google Scholar]
  25. Bliss RR, Kaufman GG. 2006. Derivatives and systemic risk: netting, collateral, and closeout. J. Financ. Stab. 2:55–70
    [Google Scholar]
  26. Boissel C, Derrien F, Örs E, Thesmar D. 2017. Systemic risk in clearing houses: evidence from the European repo market. J. Financ. Econ. 125:511–36
    [Google Scholar]
  27. Bolton P, Oehmke M. 2015. Should derivatives be privileged in bankruptcy?. J. Finance 70:2352–94
    [Google Scholar]
  28. Börner L, Hatfield JW. 2017. The design of debt-clearing markets: clearinghouse mechanisms in preindustrial Europe. J. Political Econ. 125:1991–2037
    [Google Scholar]
  29. Braithwaite J, Murphy D. 2016. Got to be certain: the legal framework for CCP default management processes Financ. Stab. Pap. 37 Bank Engl. London:
    [Google Scholar]
  30. Brunnermeier MK. 2009. Deciphering the liquidity and credit crunch 2007–2008. J. Econ. Perspect. 23:77–100
    [Google Scholar]
  31. Brunnermeier MK, Pedersen LH. 2005. Predatory trading. J. Finance 60:1825–63
    [Google Scholar]
  32. Brunnermeier MK, Pedersen LH. 2009. Market liquidity and funding liquidity. Rev. Financ. Stud. 22:2201–38
    [Google Scholar]
  33. Budding E, Cox RT, Murphy D. 2016. Central counterparties in crisis: International Commodities Clearing House, New Zealand Futures and Options Exchange and the Stephen Francis Affair. J. Financ. Market Infrastruct. 4:65–92
    [Google Scholar]
  34. Capponi A, Cheng A, Du C, Giglio S, Haynes R. 2020. The collateral rule: evidence from the credit default swap market. Work. Pap., Columbia Univ., New York NY:
    [Google Scholar]
  35. Carapella F, Mills DC. 2014. Information insensitive securities: the true benefits of Central Counterparties. Work. Pap., Fed. Reserve Board Gov. Washington, DC:
    [Google Scholar]
  36. Cenedese G, Ranaldo A, Vasios M 2020. OTC premia. J. Financ. Econ. 136:86–105
    [Google Scholar]
  37. Cerezetti F, Cruz-Lopez J, Manning M, Murphy D. 2019. Who pays? Who gains? Central counterparty resource provision in the post-Pittsburgh world. J. Financ. Market Infrastruct. 7:21–44
    [Google Scholar]
  38. Chodorow-Reich G. 2014. The employment effects of credit market disruptions: firm-level evidence from the 2008–9 financial crisis. Q. J. Econ. 129:1–59
    [Google Scholar]
  39. Collin-Dufresne P, Junge B, Trolle AB 2020. Market structure and transaction costs of Index CDSs. J. Finance 75:2719–63
    [Google Scholar]
  40. Cont R, Kokholm T. 2014. Central clearing of OTC derivatives: bilateral vs multilateral netting. Stat. Risk Model. 31:3–22
    [Google Scholar]
  41. Cox RT. 2015. Central counterparties in crisis: The Hong Kong Futures Exchange in the crash of 1987. J. Financ. Market Infrastruct. 4:73–98
    [Google Scholar]
  42. Cox RT, Steigerwald RS. 2016. “Incomplete demutualization” and financial market infrastructure: central counterparty ownership and governance after the crisis of 2008–9. J. Financ. Market Infrastruct. 4:25–38
    [Google Scholar]
  43. Cox RT, Steigerwald RS. 2018. A CCP is a CCP is a CCP. J. Financ. Market Infrastruct. 6:1–18
    [Google Scholar]
  44. CPMI-IOSCO (Comm. Paym. Market Infrastr.–Int. Org. Secur. Comm.) 2012. Principles for financial market infrastructures. Regul. Rep., CPMI-IOSCO Madrid, Spain:
    [Google Scholar]
  45. CPMI-IOSCO (Comm. Paym. Market Infrastr.–Int. Org. Secur. Comm.) 2015. Public quantitative disclosure standards for central counterparties. Regul. Rep., CPMI-IOSCO Madrid, Spain:
    [Google Scholar]
  46. CPMI-IOSCO (Comm. Paym. Market Infrastr.–Int. Org. Secur. Comm.) 2016. Implementation monitoring of PFMI: Level 3 assessment—report on the financial risk management and recovery practices of 10 derivatives CCPs CPMI Pap. 148 CPMI-IOSCO Madrid, Spain:
    [Google Scholar]
  47. CPMI-IOSCO (Comm. Paym. Market Infrastr.–Int. Org. Secur. Comm.) 2017. Resilience and recovery of central counterparties (CCPs): further guidance on the PFMI CPMI Pap. 163 CPMI-IOSCO Madrid, Spain:
    [Google Scholar]
  48. Cruz Lopez J, Hurlin C, Harris JH, Pérignon C 2017. CoMargin. J. Financ. Quant. Anal. 52:2183–215
    [Google Scholar]
  49. Davison IH. 1988. The operation and regulation of the Hong Kong securities industry Rep., May 27 Secur. Rev. Comm. Hong Kong:
    [Google Scholar]
  50. Depitre E. 1907. Les caisses de liquidation des opérations à terme sur marchandises. Paris: Arthur Rousseau
    [Google Scholar]
  51. Duffie D 2015. Resolution of failing central counterparties. Making Failure Feasible: How Bankruptcy Reform Can End `Too Big To Fail', ed. T Jackson, K Scott, JE Taylor 87–109 Stanford, CA: Hoover Inst. Press
    [Google Scholar]
  52. Duffie D 2020. Still the world's safe haven? Redesigning the U.S. Treasury market after the COVID-19 crisis. Work. Pap., Hutchins Cent. Fiscal Monet. Policy, Brookings Inst. Washington, DC:
    [Google Scholar]
  53. Duffie D, Scheicher M, Vuillemey G. 2015. Central clearing and collateral demand. J. Financ. Econ. 116:237–56
    [Google Scholar]
  54. Duffie D, Skeel DA 2012. A dialogue on the costs and benefits of automatic stays for derivatives and repurchase agreements. Bankruptcy Not Bailout: A Special Chapter 14 KE Scott, JB Taylor 133–73 Stanford, CA: Hoover Inst. Press
    [Google Scholar]
  55. Duffie D, Zhu H 2011. Does a central clearing counterparty reduce counterparty risk?. Rev. Asset Pricing Stud. 1:74–95
    [Google Scholar]
  56. Emery HC. 1896. Speculation on the Stock and Produce Exchanges of the United States New York: Greenwood Press
    [Google Scholar]
  57. Ferrara G, Li X, Marszalec D. 2019. Central counterparty auction design. J. Financ. Market Infrastruct. 8:47–58
    [Google Scholar]
  58. Financ. Stab. Board 2019. OTC derivatives market reforms: 2019 progress report on implementation Rep., Oct. 15 Financ. Stab. Board, Basel Switz:.
    [Google Scholar]
  59. France VG, Kahn CM. 2016. Law as a constraint on bailouts: emergency support for central counterparties. J. Financ. Intermed. 28:22–31
    [Google Scholar]
  60. Freixas X, Rochet JC. 2008. Microeconomics of Banking Cambridge, MA: MIT Press
    [Google Scholar]
  61. Garleanu N, Pedersen LH. 2011. Margin-based asset pricing and deviations from the law of one price. Rev. Financ. Stud. 24:1980–2022
    [Google Scholar]
  62. Garratt R, Zimmerman P. 2020. Centralized netting in financial networks. J. Bank. Finance 112:1–16
    [Google Scholar]
  63. Ghamami S, Glasserman P. 2017. Does OTC derivatives reform incentivize central clearing?. J. Financ. Intermed. 32:76–87
    [Google Scholar]
  64. Glasserman P, Moallemi CC, Yuan K. 2016. Hidden illiquidity with multiple central counterparties. Oper. Res. 64:1143–58
    [Google Scholar]
  65. Gorton G. 1985. Clearinghouses and the origin of central banking in the United States. J. Econ. Hist. 45:277–83
    [Google Scholar]
  66. Gorton G, Mullineaux DJ. 1987. The joint production of confidence: endogenous regulation and nineteenth century commercial-bank clearinghouses. J. Money Credit Bank. 19:457–68
    [Google Scholar]
  67. Gorton G, Pennacchi G. 1990. Financial intermediaries and liquidity creation. J. Finance 45:49–71
    [Google Scholar]
  68. Gregory J. 2015. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral and Capital Chichester, UK: Wiley
    [Google Scholar]
  69. Gromb D, Vayanos D. 2002. Equilibrium and welfare in markets with financially constrained arbitrageurs. J. Financ. Econ. 66:361–407
    [Google Scholar]
  70. Hardouvelis GA. 1990. Margin requirements, volatility, and the transitory component of stock prices. Am. Econ. Rev. 80:736–62
    [Google Scholar]
  71. Hardouvelis GA, Peristiani S. 1992. Margin requirements, speculative trading, and stock price fluctuations: the case of Japan. Q. J. Econ. 107:1333–70
    [Google Scholar]
  72. Hart O, Moore J. 1996. The governance of exchanges: members' cooperatives versus outside ownership. Oxf. Rev. Econ. Policy 12:53–69
    [Google Scholar]
  73. Hendershott T, Menkveld AJ. 2014. Price pressures. J. Financ. Econ. 114:405–23
    [Google Scholar]
  74. Hills B, Rule D, Parkinson S, Young C. 1999. Central counterparty clearing houses and financial stability. Financ. Stab. Rev. 6:122–34
    [Google Scholar]
  75. Ho T, Stoll HR. 1981. Optimal dealer pricing under transaction cost and return uncertainty. J. Financ. Econ. 9:47–73
    [Google Scholar]
  76. Holmström B, Tirole J. 1997. Financial intermediation, loanable funds, and the real sector. Q. J. Econ. 112:663–91
    [Google Scholar]
  77. Hsieh DA, Miller MH. 1990. Margin regulation and stock market volatility. J. Finance 45:3–29
    [Google Scholar]
  78. Huang W. 2019. Central counterparty capitalization and misaligned incentives Work. Pap. 767 Bank Int. Settl. Basel, Switz:.
    [Google Scholar]
  79. Huang W, Menkveld AJ, Yu S 2021. Central counterparty exposure in stressed markets. Manag. Sci. 67:63596617
    [Google Scholar]
  80. Huang W, Takáts E. 2020. Model risk at central counterparties: Is skin-in-the-game a game changer? Work. Pap. 866 Bank Int. Settl Basel, Switz:.
    [Google Scholar]
  81. Jensen MC, Meckling WH. 1976. Theory of the firm: managerial behavior, agency cost, and capital structure. J. Financ. Econ. 3:305–60
    [Google Scholar]
  82. Jones R, Pérignon C. 2013. Derivatives clearing, default risk, and insurance. J. Risk Insur. 80:373–400
    [Google Scholar]
  83. Katz ML, Shapiro C. 1985. Network externalities, competition, and compatibility. Am. Econ. Rev. 75:424–40
    [Google Scholar]
  84. Katz ML, Shapiro C. 1986. Technology adoption in the presence of network externalities. J. Political Econ. 94:822–41
    [Google Scholar]
  85. Keeley MC. 1990. Deposit insurance, risk, and market power in banking. Am. Econ. Rev. 80:1183–200
    [Google Scholar]
  86. Koeppl T, Monnet C. 2010. The emergence and future of central counterparties Work. Pap. 1241 Queen's Univ., Kingston Can:.
    [Google Scholar]
  87. Koeppl T, Monnet C, Temzelides T. 2012. Optimal clearing arrangements for financial trades. J. Financ. Econ. 103:189–203
    [Google Scholar]
  88. Kroszner RS. 1999. Can the financial markets privately regulate risk? The development of derivatives clearinghouses and recent over-the-counter innovations. J. Money Credit Bank. 31:596–618
    [Google Scholar]
  89. Kuong JCF. 2020. Self-fulfilling fire sales: fragility of collateralized short-term debt markets. Rev. Financ. Stud hhaa115. https://doi.org/10.1093/rfs/hhaa115
    [Crossref] [Google Scholar]
  90. Kuong JCF, Maurin V. 2020. The design of a central counterparty. Work. Pap., INSEAD Singapore:
    [Google Scholar]
  91. Leitner Y. 2012. Inducing agents to report hidden trades: a theory of an intermediary. Rev. Finance 16:1013–42
    [Google Scholar]
  92. Loon YC, Zhong ZK. 2014. The impact of central clearing on counterparty risk, liquidity, and trading: Evidence from the credit default swap market. J. Financ. Econ. 112:91–115
    [Google Scholar]
  93. Loon YC, Zhong ZK. 2016. Does Dodd-Frank affect OTC transaction costs and liquidity? Evidence from real-time CDS trade reports. J. Financ. Econ. 119:645–72
    [Google Scholar]
  94. Lubben SJ 2017. Lehman's derivative portfolio. Bank Failure: Lessons from Lehman Brothers D Faber, N Vermunt 59–74 Oxford, UK: Oxford Univ. Press
    [Google Scholar]
  95. Mancini L, Ranaldo A, Wrampelmeyer J. 2016. The euro interbank repo market. Rev. Financ. Stud. 29:1747–79
    [Google Scholar]
  96. Mayordomo S, Posch PN. 2016. Does central clearing benefit risky dealers?. J. Int. Financ. Markets Inst. Money 42:91–100
    [Google Scholar]
  97. McSherry B, Wilson BK, McAndrews JJ. 2017. Net settlement and counterparty risk: evidence from the formation of the New York Stock Exchange Clearing House in 1892. J. Money Credit Bank. 49:1273–98
    [Google Scholar]
  98. Menkveld AJ. 2017a. Crowded trades: an overlooked systemic risk for central clearing counterparties. Rev. Asset Pricing Stud. 7:209–42
    [Google Scholar]
  99. Menkveld AJ. 2017b. Systemic risk in central clearing: Should crowded trades be avoided? SSRN Work. Pap. 2367287
    [Google Scholar]
  100. Menkveld AJ, Pagnotta E, Zoican MA. 2015. Does central clearing affect price stability? Evidence from Nordic equity markets SSRN Work. Pap. 2350762
    [Google Scholar]
  101. Modigliani F, Miller M. 1958. The cost of capital, corporate finance and the theory of investment. Am. Econ. Rev. 48:261–97
    [Google Scholar]
  102. Moser JT. 1998. Contracting innovations and the evolution of clearing and settlement methods at futures exchanges Work. Pap. Ser. WP-98-26 Fed. Res. Bank Chicago
    [Google Scholar]
  103. Murphy D. 2013. OTC Derivatives: Bilateral Trading and Central Clearing: An Introduction to Regulatory Policy, Market Impact and Systemic Risk. New York: Palgrave Macmillan
    [Google Scholar]
  104. Murphy D. 2020. Too much, too young: improving the client clearing mandate. J. Financ. Market Infrastruct. 8:29–50
    [Google Scholar]
  105. Murphy D, Vasios M, Vause N. 2014. An investigation into the procyclicality of risk-based initial margin models Financ. Stab. Work. Pap. 29 Bank Engl. London:
    [Google Scholar]
  106. Norman P. 2011. The Risk Controllers: Central Counterparty Clearing in Globalised Financial Markets. Chichester, UK: Wiley
    [Google Scholar]
  107. Paddrik M, Rajan S, Young PH. 2020a. Contagion in the derivative markets. Manag. Sci. 66:3603–16
    [Google Scholar]
  108. Paddrik M, Rajan S, Young PH 2020b. How safe are central counterparties in credit default swap markets?. Math. Financ. Econ. 15:41–57
    [Google Scholar]
  109. Pedersen LH. 2009. When everyone runs for the exit. Int. J. Cent. Bank. 5:177–99
    [Google Scholar]
  110. Pirrong C. 2000. A theory of financial exchange organization. J. Law Econ. 43:437–71
    [Google Scholar]
  111. Pirrong C. 2011. The economics of central clearing: theory and practice Discuss. Pap. Ser. 1 Int. Swaps Deriv. Assoc., New York NY:
    [Google Scholar]
  112. Rampini A, Viswanathan S. 2010. Collateral, risk management, and the distribution of debt capacity. J. Finance 65:2293–322
    [Google Scholar]
  113. Ranaldo A, Schaffner P, Vasios M. 2021. Regulatory effects on short-term interest rates. J. Financ. Econ 141:275070
    [Google Scholar]
  114. Roe MJ, Adams SD. 2015. Restructuring failed financial firms in bankruptcy: selling Lehman's derivatives portfolio. Yale J. Regul. 32:2363–411
    [Google Scholar]
  115. Schaede U. 1989. Forwards and futures in Tokugawa-period Japan: a new perspective on the Dojima rice market. J. Bank. Finance 13:487–513
    [Google Scholar]
  116. Shleifer A, Vishny RW. 1997. A survey of corporate governance. J. Finance 52:737–83
    [Google Scholar]
  117. Spatt CS. 2021. Designing Reliable Clearing and Settlement Systems for Enhancing the Transparency and Stability of Derivatives Markets. Philadelphia: Wharton. In press
    [Google Scholar]
  118. Stiglitz J. 1969. A re-examination of the Modigliani-Miller theorem. Am. Econ. Rev. 59:784–93
    [Google Scholar]
  119. Story L. 2010. A secretive banking elite rules trading in derivatives. New York Times Dec. 11
    [Google Scholar]
  120. Summe KA 2012. An examination of Lehman Brothers' derivatives portfolio postbankruptcy: Would Dodd-Frank have made a difference?. Bankruptcy Not Bailout KE Scott, JB Taylor 85–131 Stanford, CA: Hoover Inst. Press
    [Google Scholar]
  121. Vuillemey G. 2020a. Mitigating fire sales with a central clearing counterparty SSRN Work. Pap. 3355142
    [Google Scholar]
  122. Vuillemey G. 2020b. The value of central clearing. J. Finance 75:2021–53
    [Google Scholar]
  123. Wang JJ, Capponi A, Zhang H. 2018. A theory of collateral requirements for central counterparties Work. Pap., Columbia Univ., New York NY:
    [Google Scholar]
  124. Woodall L. 2020a. Initial margin models of top CCPs slipped in Q1. Risk.net July 6
    [Google Scholar]
  125. Woodall L. 2020b. SwapClear incurred a $558m margin breach in Q1. Risk.net July 1
    [Google Scholar]
/content/journals/10.1146/annurev-financial-100520-100321
Loading
/content/journals/10.1146/annurev-financial-100520-100321
Loading

Data & Media loading...

  • Article Type: Review Article
This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error