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Financial Stability Paper No 20: Central counterparty loss-allocation rules

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  • Elliott, David

    (Bank of England)

Abstract

Given the increasingly important role of central counterparties (CCPs) in many financial markets, the insolvency of a CCP could be highly disruptive to the financial system if losses fall on participants in an uncertain and disorderly manner. In contrast to most other financial firms, CCPs’ obligations to their members, and vice versa, are governed by a central rulebook. CCPs have the ability to include in this rulebook rules setting out how losses exceeding the CCP’s pre-funded default resources are to be allocated between participants. Indeed, some CCPs have already done so. We term such rules ‘loss-allocation rules’. These could have the advantages, relative to the counterfactual of the disorderly insolvency of the CCP, of offering transparency and predictability to participants; providing for a quick and orderly allocation of losses; and potentially allowing the CCP to continue to provide critical services to the market. The detailed design of such rules has important implications for financial stability, as well as for the CCP and its stakeholders. Given these considerations, there is ongoing international work on the design of loss-allocation rules. This paper analyses the options available and offers principles to guide the design of loss-allocation rules.

Suggested Citation

  • Elliott, David, 2013. "Financial Stability Paper No 20: Central counterparty loss-allocation rules," Bank of England Financial Stability Papers 20, Bank of England.
  • Handle: RePEc:boe:finsta:0020
    Note: http://www.bankofengland.co.uk/financialstability/Pages/fpc/fspapers/fs_paper20.aspx
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    References listed on IDEAS

    as
    1. Murphy, Emma & Senior, Stephen, 2013. "Changes to the Bank of England," Bank of England Quarterly Bulletin, Bank of England, vol. 53(1), pages 20-28.
    2. Nahai-Williamson, Paul & Ota, Tomohiro & Vital, Mathieu & Wetherilt, Anne, 2013. "Financial Stability Paper No 19: Central counterparties and their financial resources – a numerical approach," Bank of England Financial Stability Papers 19, Bank of England.
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    Cited by:

    1. Ms. Froukelien Wendt, 2015. "Central Counterparties: Addressing their Too Important to Fail Nature," IMF Working Papers 2015/021, International Monetary Fund.
    2. Gabrielle Demange & Thibaut Piquard, 2021. "On the market structure of central counterparties in the EU," PSE Working Papers halshs-03107812, HAL.
    3. 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.
    4. Alexandra Heath & Gerard Kelly & Mark Manning, 2015. "Central Counterparty Loss Allocation and Transmission of Financial Stress," RBA Research Discussion Papers rdp2015-02, Reserve Bank of Australia.
    5. Nahai-Williamson, Paul & Ota, Tomohiro & Vital, Mathieu & Wetherilt, Anne, 2013. "Financial Stability Paper No 19: Central counterparties and their financial resources – a numerical approach," Bank of England Financial Stability Papers 19, Bank of England.
    6. Darrell Duffie, 2014. "Financial Market Infrastructure: Too Important to Fail," Book Chapters, in: Martin Neil Baily & John B. Taylor (ed.), Across the Great Divide: New Perspectives on the Financial Crisis, chapter 11, Hoover Institution, Stanford University.
    7. Vincent Bignon & Guillaume Vuillemey, 2020. "The Failure of a Clearinghouse: Empirical Evidence [Counterparty risk externality: centralized versus over-the-counter markets]," Review of Finance, European Finance Association, vol. 24(1), pages 99-128.
    8. Wenqian Huang, 2019. "Central counterparty capitalization and misaligned incentives," BIS Working Papers 767, Bank for International Settlements.
    9. Andrew W Lo, 2016. "Moore's Law vs. Murphy's Law in the financial system: who's winning?," BIS Working Papers 564, Bank for International Settlements.
    10. Demange, Gabrielle & Piquard, Thibaut, 2023. "On the choice of central counterparties in the EU," Journal of Financial Markets, Elsevier, vol. 64(C).
    11. Kubitza, Christian & Pelizzon, Loriana & Getmansky, Mila, 2018. "The pitfalls of central clearing in the presence of systematic risk," ICIR Working Paper Series 31/18, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    12. Lannoo, Karel, 2017. "Derivatives Clearing and Brexit: A comment on the proposed EMIR revisions," ECMI Papers 13150, Centre for European Policy Studies.
    13. Rahman, Arshadur, 2015. "Over-the-counter (OTC) derivatives, central clearing and financial stability," Bank of England Quarterly Bulletin, Bank of England, vol. 55(3), pages 283-294.
    14. Rehlon, Amandeep & Nixon, Dan, 2013. "Central counterparties: what are they, why do they matter and how does the Bank supervise them?," Bank of England Quarterly Bulletin, Bank of England, vol. 53(2), pages 147-156.
    15. Gaetano Antinolfi & Francesca Carapella & Francesco Carli, 2019. "Transparency and Collateral: The Design of CCPs' Loss Allocation Rules," Finance and Economics Discussion Series 2019-058, Board of Governors of the Federal Reserve System (U.S.).
    16. Boissel, Charles & Derrien, François & Ors, Evren & Thesmar, David, 2017. "Systemic risk in clearing houses: Evidence from the European repo market," Journal of Financial Economics, Elsevier, vol. 125(3), pages 511-536.
    17. Cumming, Fergus & Noss, Joseph, 2013. "Financial Stability Paper No 26: Assessing the adequacy of CCPs' default resources," Bank of England Financial Stability Papers 26, Bank of England.
    18. Radoslav Raykov, 2016. "To Share or Not to Share? Uncovered Losses in a Derivatives Clearinghouse," Staff Working Papers 16-4, Bank of Canada.
    19. Francesco Palazzo, 2016. "Peer monitoring via loss mutualization," Temi di discussione (Economic working papers) 1088, Bank of Italy, Economic Research and International Relations Area.
    20. Matt Gibson, 2013. "Recovery and Resolution of Central Counterparties," RBA Bulletin (Print copy discontinued), Reserve Bank of Australia, pages 39-48, December.

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    More about this item

    Keywords

    financial regulations; central counter parties;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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