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Can the Financial Markets Privately Regulate Risk? The Development of Derivatives Clearinghouses and Recent Over-the-Counter Innovations

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  • Kroszner, Randall S

Abstract

This paper explores how organization and contract design has evolved to address regulatory challenges in risk management. In the early part of the century, futures exchanges responded to credit risks by developing clearinghouses that act as guarantors. The liability structure of the clearinghouse involves mutualization of risks through "partial permanent" integration of the exchange members. Bank clearinghouses historically involved "contingent" integration and risk mutualization during panics. Recent organizational innovations have allowed the risk-control benefits of the clearinghouse to be replicated in the decentralized over-the-counter derivatives markets. Credit rating agencies and advances in risk modeling are key to permitting the recent "dis-integration," which has implications for the scope of public versus private regulation in banking and financial markets.

Suggested Citation

  • Kroszner, Randall S, 1999. "Can the Financial Markets Privately Regulate Risk? The Development of Derivatives Clearinghouses and Recent Over-the-Counter Innovations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 596-618, August.
    • Handle: RePEc:mcb:jmoncb:v:31:y:1999:i:3:p:596-618
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    Citations

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    Cited by:

    1. Philip E. Strahan, 2013. "Too Big to Fail: Causes, Consequences, and Policy Responses," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 43-61, November.
    2. Edward J. Balleisen & Elizabeth K. Brake, 2014. "Historical perspective and better regulatory governance: An agenda for institutional reform," Regulation & Governance, John Wiley & Sons, vol. 8(2), pages 222-245, June.
    3. Randall S. Kroszner, 2000. "The supply of and demand for financial regulation : public and private competition around the globe : commentary," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 137-149.
    4. G. Thomas Kingsley & Travis D. Nesmith & Anna L. Paulson & Todd Prono, 2019. "Central Clearing and Systemic Liquidity Risk," Working Paper Series WP 2019-12, Federal Reserve Bank of Chicago.
    5. Andrea Attar & Catherine Casamatta & Arnold Chassagnon & Jean-Paul Décamps, 2019. "Multiple Lenders, Strategic Default, and Covenants," American Economic Journal: Microeconomics, American Economic Association, vol. 11(2), pages 98-130, May.
    6. Berndsen, Ron, 2020. "Five Fundamental Questions on Central Counterparties," Other publications TiSEM 1f3bd844-92ab-4104-8f57-9, Tilburg University, School of Economics and Management.
    7. Olga Lewandowska, 2015. "OTC Clearing Arrangements for Bank Systemic Risk Regulation: A Simulation Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(6), pages 1177-1203, September.
    8. Corbet, Shaen & Hou, Yang & Hu, Yang & Oxley, Les, 2020. "The influence of the COVID-19 pandemic on asset-price discovery: Testing the case of Chinese informational asymmetry," International Review of Financial Analysis, Elsevier, vol. 72(C).
    9. Dr. Robert Oleschak, 2019. "Central Counterparty Auctions and Loss Allocation," Working Papers 2019-06, Swiss National Bank.
    10. 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.
    11. Randall S. Kroszner & Philip E. Strahan, 2011. "Financial Regulatory Reform: Challenges Ahead," American Economic Review, American Economic Association, vol. 101(3), pages 242-246, May.
    12. Carruthers, Bruce G., 2013. "Diverging derivatives: Law, governance and modern financial markets," Journal of Comparative Economics, Elsevier, vol. 41(2), pages 386-400.
    13. Randall Kroszner, 2000. "Lessons from Financial Crises: The Role of Clearinghouses," Journal of Financial Services Research, Springer;Western Finance Association, vol. 18(2), pages 157-171, December.
    14. Mark Paddrik & Simpson Zhang, 2019. "Central Counterparty Default Waterfalls and Systemic Loss," 2019 Meeting Papers 213, Society for Economic Dynamics.
    15. João Granja, 2018. "Disclosure Regulation in the Commercial Banking Industry: Lessons from the National Banking Era," Journal of Accounting Research, Wiley Blackwell, vol. 56(1), pages 173-216, March.
    16. John P Jackson & Mark J Manning, 2007. "Comparing the pre-settlement risk implications of alternative clearing arrangements," Bank of England working papers 321, Bank of England.
    17. Kahn, Charles M. & Roberds, William, 2009. "Why pay? An introduction to payments economics," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 1-23, January.
    18. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, University Library of Munich, Germany.
    19. Thomas B. King & Travis D. Nesmith & Anna Paulson & Todd Prono, 2023. "Central Clearing and Systemic Liquidity Risk," International Journal of Central Banking, International Journal of Central Banking, vol. 19(4), pages 85-142, October.
    20. Chryssa Papathanassiou, 2012. "Central Counterparties and Derivatives," Chapters, in: Kern Alexander & Rahul Dhumale (ed.), Research Handbook on International Financial Regulation, chapter 11, Edward Elgar Publishing.

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