The Economics of Central Clearing: Theory and Practice

ISDA
May 2011

Summary
Central clearing can provide significant benefits to the stability of the financial system. Current statistics indicate that approximately 50 percent of the interest rate swaps volume outstanding has been cleared, and over $17 trillion of credit default swaps has been cleared.

This paper points out both the benefits and potential issues related to central counterparty clearing facilities (CCPs). Several of its more important conclusions include:

• CCPs can successfully reduce and reallocate counterparty risk through rigorous preparation for, and management of, member defaults;
• CCPs can also create systemic risk, and it is imperative they have strong and conservative risk management and sufficient financial resources to withstand stressed markets. They also require close supervision by regulators;
• The margin policies of CCPs can pose risks to the efficient functioning of the financial system. Mandatory clearing of OTC derivatives will lead to a large amount of liquidity being tied up as margin at CCPs. Increases in margin requirements by CCPs during a crisis could be destabilizing;
• CCPs should generally align control, governance and membership requirements with the interests of participants that absorb their risks and share their losses.