The emergence and future of central counterparties

The authors explain why central counterparties (CCPs) emerged historically. With standardized contracts, it is optimal to insure counterparty risk by clearing those contracts through a CCP that uses novation and mutualization. As netting is not essential for these services, it does not explain why CCPs exist. In over-the-counter markets, as contracts are customized and not fungible, a CCP cannot fully guarantee contract performance. Still, a CCP can help: As bargaining leads to an inefficient allocation of default risk relative to the gains from customization, a transfer scheme is needed. A CCP can implement it by offering partial insurance for customized contracts.Risk management ; Over-the-counter markets ; Contracts

The Emergence and Future of Central Counterparties

We study the role of a central counterparty (CCP) in controlling counterparty risk. When trading is organized via a centralized exchange with fungible contracts -- as in a futures market -- we show that it is optimal to clear trades via a CCP that uses (i) novation to pool the risk of default and (ii) mutualization of losses to insure against the aggregate cost of default in the form of price risk. We then analyze the design of CCP clearing for over-the-counter (OTC) trades where contracts are customized and, hence, not fungible. A CCP can still offer gains from novation by pooling default risk across all customized contracts. Bargaining in OTC trades leads to an inefficient allocation of default risk across trades. A transfer scheme can alleviate this inefficiency, but necessitates novation being offered by a CCP. Hence, the benefit from CCP clearing for OTC markets goes beyond simple netting as it is a prerequisite for an efficient allocation of default risk in such markets.Central Counterparty, Clearing, Over-the-counter Markets, Novation and Mutualization, Default Risk

Illiquidity and All Its Friends.

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macroprudential policies.

Settlement risk in large-value payments systems

The phenomenal growth of financial market and trading activities worldwide has led to tremendous growth in large-value payments systems. Large-value payments systems are the electronic banks used to transfer large payments among themselves. Payment orders processed in such systems in the United States, for example, are typically well above $1 million. ; The tremendous growth of payments system use throughout the world has increased both the possibility of settlement failures and the potential impact of such failures. In 1996, the average turnover in a single day exceeded the combined capital of the top 100 U.S. banks. Regulators are especially concerned that payments systems might turn a local financial crisis into a global systemic crisis. Shen examines settlement risk in large-value payments systems and discusses some of the measures available to manage such risk.Risk ; Payment systems ; Electronic funds transfers

The evolution of clearing and central counterparty services for exchange-traded derivatives in the United States and Europe - a comparison

This paper is organised as follows. Section 1 explains why issues concerning central counterparty clearing houses are of direct concern to central banks and why a comparison of the European and the US situation is of interest. Section 2 provides a comparative overview of the organisation of derivatives exchanges in the United States and in Europe. Section 3 focuses on the organisation of clearing, covering a broad range of aspects. Section 4 analyses operational developments in international risk management practices and arrangements. Section 5 discusses various forms of structural consolidation in the clearing and settlement infrastructure by highlighting the different approaches taken in the United States and in Europe. Section 6 is devoted to the roles of central banks and financial market regulators regarding clearing and to the challenges they face as a result of current innovations in clearing arrangements. Finally, Section 7 summarises some of the main findings.

Illiquidity and all its Friends

The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macro-prudential policies.Liquidity, Contagion, Bailouts, Regulation

The implementation of the european central bank project,target2 securities, in the european settlement system

Dissertation presented as the partial requirement for obtaining a Master's degree in Statistics and Information Management, specialization in Risk Analysis and ManagementPost-trade market in the European Union continues to be fragmented at the national level, despite the various legislative initiatives, as UCITS 5, CSDR, that brings more harmonization in investments. This issue was taken in the center of focus of the Central Bank and European Commission, that developed a successor for the Target 2 Project, called Target to Securities. With T2S, the settlement of securities between the 17 CSDs will be done uniformized, faster and safer, all the transactions being settled on a single pan-European platform in central bank. It is one of the largest infrastructure projects launched by the Eurosystem so far and it brings substantial benefits to the European post-trading industry, by revolutionizing the way securities market works. T2S is meant to dismantle the 10 technical barriers identified by the Giovannini Group. The costs of the implementation were shared between the participant CSDs. The future benefits are foreseen to be great costs savings for a unit transaction, and harmonization of the flow of a cross border transaction, like a domestic one

Efficient systems for the securities transaction industry : a framework for the European Union

This paper provides a framework for the securities transaction industry in the EU to understand the functions performed, the institutions involved and the parameters concerned that shape market and ownership structure. Of particular interest are microeconomic incentives of the industry players that can be in contradiction to social welfare. We evaluate the three functions and the strategic parameters - the boundary decision, the communication standard employed and the governance implemented - along the lines of three efficiency concepts. By structuring the main factors that influence these concepts and by describing the underlying trade-offs among them, we provide insight into a highly complex industry. Applying our framework, the paper describes and analyzes three consistent systems for the securities transaction industry. We point out that one of the systems, denoted as 'contestable monopolies', demonstrates a superior overall efficiency while it might be the most sensitive in terms of configuration accuracy and thus difficult to achieve and sustain

Central clearing configurations : implications for South African derivative markets

After the financial crisis of 2008-2009, central counterparties (CCPs) emerged as an important mechanism to mitigate against counterparty credit risk and stem the spread of contagion in a time of crisis. Trading in derivative instruments, especially opaque, illiquid and complex in-struments, were seen as the cause of much of the quagmire in which the global economy found itself. At the Pittsburgh summit in 2009, the Group of 20 Nations (G20) made some fundamental commitments on the reform of international derivatives markets. One of the main commitments was to have standardised OTC derivatives cleared through central coun-terparties by the year 2020. In South Africa, the only CCP is the clearing house for exchange traded derivatives operated by the Johannesburg Stock Exchange (JSE); five major South Af-rican banks are direct clearing members of JSE Clear. Most of the standardised OTC deriva-tive transactions are interest rate, and to a much lesser degree forex, in nature. The London Clearing House (LCH) clears the vast majority of centrally cleared ZAR interest rate swaps. All South African banks clear most of their trades executed with foreign counterparts at LCH but only one has a subsidiary that is a direct clearing member of LCH. There is a large amount of ZAR interest rate swap activity in SA which is not centrally cleared. This study examines the efficiency and dynamics of central clearing in this setting. It further notes the recent de-velopments in the current central clearing landscape and compares aspects thereof in South Africa to international CCPs. The framework developed by Duffie & Zhu (2011) is then used to examine efficiencies of different configurations of central clearing of derivatives in the South African context.Dissertation (MSc (Financial Engineering))--University of Pretoria, 2021.Mathematics and Applied MathematicsMSc (Financial Engineering)Unrestricte

Spillover Across Remedies

Remedies influence rights, and rights apply across remedies. Combined together, these two phenomena produce the problem of spillover across remedies. The spillover problem occurs when considerations specific to one remedy affect the definition of a substantive rule that governs in other remedial settings. For example, the severe remedial consequences of suppressing incriminating evidence might generate substantive Fourth Amendment precedents that make other Fourth Amendment remedies (such as damage awards, injunctions, or ex ante denials of search warrants) more difficult to obtain. Or, the rule of lenity might yield a narrowed reading of a statutory rule in a criminal case, which then carries binding effect on subsequent attempts to secure civil relief under the same statutory provision. In these and other contexts, the cross-remedial scope of substantive rules can give rise to significant doctrinal distortions, with one remedy’s influence on a substantive norm dictating the outcome of cases that would otherwise implicate different remedial considerations. This Article documents several examples of cross-remedial spillover and considers several possible responses to it. Its central conclusion is that courts can best manage the spillover problem by varying the applicability of substantive rules across different remedial domains. Such disaggregation strategies already exist to some extent in the law, implemented most often through the use of discrete, transsubstantive exceptions to remedial requirements (consider, for instance, the qualified immunity defense to damages liability under § 1983, or the harmless error exception to the reversal remedy on direct appeals). Nonetheless, as this Article demonstrates, courts can more effectively disaggregate substantive norms — and thus more effectively mitigate spillover across remedies — by utilizing a significantly more nuanced and substance-specific set of remedial exceptions. In effect, such an approach would yield hybridized rules of right-remedy law, with precedential effects extending no further than particularized combinations of substantive and remedial domains. Although that outcome might give some readers pause, it is in fact a sensible and feasible objective for courts to pursue