IDEAS home Printed from https://ideas.repec.org/p/bno/worpap/2015_16.html
   My bibliography  Save this paper

The end of the waterfall: default resources of central counterparties

Author

Listed:
  • Rama Cont

    (Imperial College London)

Abstract

Central counterparties (CCPs) have become pillars of the new global financial architecture following the financial crisis of 2008. The key role of CCPs in mitigating counterparty risk and contagion has in turn cast them as systemically important financial institutions whose eventual failure may lead to potentially serious consequences for financial stability, and prompted discussions on CCP risk management standards and safeguards for recovery and resolutions of CCPs in case of failure. We contribute to the debate on CCP default resources by focusing on the incentives generated by the CCP loss allocation rules for the CCP and its members and discussing how the design of loss allocation rules may be used to align these incentives in favor of outcomes which benefit financial stability. After reviewing the ingredients of the CCP loss waterfall and various proposals for loss recovery provisions for CCPs, we examine the risk management incentives created by different ingredients in the loss waterfall and discuss possible approaches for validating the design of the waterfall. We emphasize the importance of CCP stress tests and argue that such stress tests need to account for the interconnectedness of CCPs through common members and cross-margin agreements. A key proposal is that capital charges on assets held against CCP Default Funds should depend on the quality of the risk management of the CCP, as assessed through independent stress tests.

Suggested Citation

  • Rama Cont, 2015. "The end of the waterfall: default resources of central counterparties," Working Paper 2015/16, Norges Bank.
    • Handle: RePEc:bno:worpap:2015_16
    as

    Download full text from publisher

    File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2015/162015/
    Download Restriction: no
    ---><---

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mark Paddrik & Simpson Zhang, 2019. "Central Counterparty Default Waterfalls and Systemic Loss," 2019 Meeting Papers 213, Society for Economic Dynamics.
    2. Christian Kubitza & Loriana Pelizzon & Mila Getmansky Sherman, 2021. "Loss Sharing in Central Clearinghouses: Winners and Losers," ECONtribute Discussion Papers Series 066, University of Bonn and University of Cologne, Germany.
    3. Tathagata Banerjee & Zachary Feinstein, 2018. "Impact of Contingent Payments on Systemic Risk in Financial Networks," Papers 1805.08544, arXiv.org, revised Dec 2018.
    4. Ricardo Mariño-Martínez & Carlos León & Carlos Cadena-Silva, 2020. "Las entidades de contrapartida central en la mitigación del riesgo de contraparte y de liquidez: El caso de los derivados cambiarios en Colombia," Borradores de Economia 1101, Banco de la Republica de Colombia.
    5. Injun Hwang & Baeho Kim, 2020. "Heterogeneity and netting efficiency under central clearing: A stochastic network analysis," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(2), pages 192-208, February.
    6. Christoph Aymanns & J. Doyne Farmer & Alissa M. Keinniejenhuis & Thom Wetzer, 2017. "Models of Financial Stability and their Application in Stress Tests," Working Papers on Finance 1805, University of St. Gallen, School of Finance.
    7. Maximilian Jager & Frederick Zadow, 2023. "Clear(ed) Decision: The Effect of Central Clearing on Firms Financing Decision," CRC TR 224 Discussion Paper Series crctr224_2023_445, University of Bonn and University of Mannheim, Germany.
    8. Jessie Jiaxu Wang & Agostino Capponi & Hongzhong Zhang, 2022. "A Theory of Collateral Requirements for Central Counterparties," Management Science, INFORMS, vol. 68(9), pages 6993-7017, September.
    9. Yannick Armenti & Stéphane Crépey & Samuel Drapeau & Antonis Papapantoleon, 2018. "Multivariate Shortfall Risk Allocation and Systemic Risk," Working Papers hal-01764398, HAL.
    10. Berndsen, Ron, 2020. "Five Fundamental Questions on Central Counterparties," Discussion Paper 2020-028, Tilburg University, Center for Economic Research.
    11. Ranaldo, Angelo & Schaffner, Patrick & Vasios, Michalis, 2021. "Regulatory effects on short-term interest rates," Journal of Financial Economics, Elsevier, vol. 141(2), pages 750-770.
    12. Paul Glasserman & Qi Wu, 2018. "Persistence and Procyclicality in Margin Requirements," Management Science, INFORMS, vol. 64(12), pages 5705-5724, December.
    13. Melinda Friesz & Kira Muratov-Szabó & Andrea Prepuk & Kata Váradi, 2021. "Risk Mutualization in Central Clearing: An Answer to the Cross-Guarantee Phenomenon from the Financial Stability Viewpoint," Risks, MDPI, vol. 9(8), pages 1-19, August.
    14. Samim Ghamami & Paul Glasserman, 2016. "Does OTC Derivatives Reform Incentivize Central Clearing?," Working Papers 16-07, Office of Financial Research, US Department of the Treasury.
    15. Dermot Turing & Mr. Manmohan Singh, 2018. "The Morning After--The Impact on Collateral Supply After a Major Default," IMF Working Papers 2018/228, International Monetary Fund.
    16. Ghamami, Samim & Glasserman, Paul, 2017. "Does OTC derivatives reform incentivize central clearing?," Journal of Financial Intermediation, Elsevier, vol. 32(C), pages 76-87.
    17. Ron Berndsen, 2021. "Fundamental questions on central counterparties: A review of the literature," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(12), pages 2009-2022, December.

    More about this item

    Keywords

    CCP; central clearing; central counterparty; systemic risk; default risk; counterparty risk; default fund; OTC derivatives; mechanism design; regulation; EMIR.;
    All these keywords.

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bno:worpap:2015_16. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nbgovno.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.