Jean-Claude Trichet

English

Research Papers in Economics

51 Federal Reserve Bank of Chicago
Issues related to central counterparty clearing:  
Concluding remarks
Jean-Claude Trichet
This article is a reprint of a speech by Jean-Claude Trichet, 
president of the European Central Bank, on April 4, 2006, 
at “Issues Related to Central Counterparty Clearing,”  
a joint conference of the Federal Reserve Bank of Chicago 
and the European Central Bank, held in Frankfurt, Germany, 
April 3–4, 2006. The conference agenda and presentations 
are available at www.ecb.int/events/conferences/html/ 
 ccp.en.html.
I have the pleasure to conclude a very successful con-
ference, a conference that has been special in many 
respects. First, this conference was jointly organized 
by the European Central Bank (ECB) and the Federal 
Reserve Bank of Chicago (Chicago Fed). As such, it 
marks another fruitful example of cooperation among 
central banks across the Atlantic. Second, it has fea-
tured research on central counterparties (CCPs), a topic 
that has not yet received a great deal of attention from 
academic researchers. I hope that this conference has 
contributed to stimulating more research on this very 
important subject. Finally, it has brought together mar-
ket participants, public authorities, and academics. I 
am in no doubt that discussions involving people from 
these very different groups are beneficial for all of 
them. However, I am also aware that it is not always 
easy to initiate such discussions. This conference has 
also been very successful in this respect. I wish to 
thank the organizers of this conference at the Chicago 
Fed and the ECB for all their hard work.
Central counterparties play an important role in 
many financial markets. They interpose themselves 
between the buyer and the seller of financial assets, 
acting as the buyer to every seller and as the seller to 
every buyer of a specified set of contracts. This process 
mitigates counterparty credit risk, which is the risk 
that one party of a trade suffers losses because the 
other party cannot fulfill its obligations from the trade. 
Through multilateral netting, central counterparties 
enhance liquidity and reduce liquidity costs. Finally, 
central counterparties ensure post-trade anonymity.
Central banks are interested in the smooth func-
tioning of central counterparties for three reasons:
n  Central counterparties can enhance financial stabili-
ty as long as they function smoothly. The failure of 
a central counterparty, however, can significantly 
destabilize financial markets. It is therefore impor-
tant that central counterparties have appropriate 
risk-management procedures in place;
n  Links between central counterparties operating in 
different countries can foster financial integration 
across those countries by allowing the participants 
to trade in a foreign market and to clear that trade 
through existing national arrangements. Links be-
tween CCPs can take a variety of forms, ranging 
from the establishment of direct relations between 
two CCPs to arrangements between central coun-
terparties that allow their participants to mitigate 
the costs associated with risk control measures  
(for example, cross-margining); and
n  Central counterparties use payment systems and 
other infrastructures operated by central banks to 
carry out their activities.
For these reasons, central banks closely follow 
and contribute to the discussions related to central 
counterparty clearing. This conference is an important 
element in this respect. 
Let me now outline a few central points of this 
discussion.
Central counterparties must have adequate 
risk-management procedures 
Central counterparties play a systemically impor-
tant role in many financial markets. The failure of a 
central counterparty can severely disrupt financial mar-
kets. Central counterparties are highly specialized in 
managing risks, and failures have been rare. Never-
theless, there is no room for complacency, and any  52 4Q/2006, Economic Perspectives
efforts to improve risk-management methods are most 
welcome. As mentioned already several times in this 
conference, in November 2004 the Group of Ten  
(G-10) central banks and the International Organization 
of Securities Commissions (IOSCO) issued a report 
that set out 15 comprehensive international recommen-
dations for promoting the safety and efficiency of cen-
tral counterparties. The European System of Central 
Banks–Committee of European Securities Regulators 
(ESCB–CESR) working group is working in close 
cooperation with European Union CCPs to adapt these 
recommendations to the European context. Academic 
research can provide additional hints on the specific 
situations that are targeted by the recommendations. 
This has been shown at this conference by Alejandro 
García and Ramo Gençay or John Cotter and Kevin 
Dowd with their approaches to extreme market events 
and by Froukelien Wendt in her survey on intraday 
margining.
The governance structure of central counterparties 
should in principle be market driven
The governance structure may have a significant 
influence on, for example, risk-management and other 
strategic decisions of central counterparties, as pointed 
out by Thorsten Koeppl and Cyril Monnet. Although 
the optimal governance structure cannot be defined 
ex ante, the markets may in many cases be in a good 
position to identify and produce it. Public authorities 
must, however, step in whenever market failures be-
come significant. In this respect, the ECB supports the 
views expressed in the recommendations by the Com-
mittee on Payment and Settlement Systems–Interna-
tional Organization of Securities Commissions (CPSS– 
IOSCO), according to which governance arrangements 
for a CCP should be clear and transparent in order to 
fulfill public interest requirements, support the objec-
tives of owners and participants, and, in particular, 
promote the effectiveness of a CCP’s risk-management 
procedures. 
The features of post-trading structure should 
also in principle be market driven
We are witnessing fast developments in the field 
of financial market infrastructures, especially in Europe, 
but also in other parts of the world. With respect to 
central counterparties, I would like to mention four 
major developments:
Consolidation of central counterparties
Since the start of the European Monetary Union 
(EMU), the number of central counterparties for finan-
cial instruments has fallen from 14 to seven in the 
euro area. This process of consolidation may have a 
positive impact on financial stability as larger central 
counterparties may find it easier to diversify risks. It 
may also have a positive impact on the efficiency of 
post-trading arrangements due to network effects and 
issues related to interoperability. However, the failure 
of large central counterparties could have an even 
more disastrous impact on financial markets. Moreover, 
consolidation may eventually lead to a reduction in 
competitive pressures with a negative impact on effi-
ciency. The Eurosystem has formulated this position 
in a policy statement on consolidation in central coun-
terparty clearing, which was published as early as 
September 2001. As set forth in the policy statement, 
the ECB supports any form of market-led integration 
or consolidation process that fulfills the ECB’s require-
ments in terms of financial stability, open access, price 
transparency, and efficiency.
Expansion of activities of central counterparties 
While in the past most European central counter-
parties only cleared derivatives, many of them also 
now clear securities transactions. The effects of such 
an expansion have been assessed differently by dif-
ferent speakers at this conference. On the one hand, 
John Jackson and Mark Manning have found that 
central counterparties that diversify their activities 
across imperfectly correlated assets may often be able 
to better manage their risks than single-product clear-
ers. At the same time, securities market participants 
have benefited as their exposure to counterparty credit 
risk is reduced. This trend towards multiproduct cen-
tral counterparties could therefore be beneficial from 
a financial stability perspective. On the other hand, in 
the first panel yesterday, Diana Chan had mentioned 
that central counterparties that diversify their activities 
across imperfectly correlated assets and reduce the 
collateral requirements for their participants by off-
setting margins related to these different activities 
could significantly underestimate risk exposure and 
collateralization requirements, thereby creating addi-
tional and unknown risks. These developments need, 
therefore, to be carefully observed by market partici-
pants and relevant authorities.
Creation and dismantling of vertical “silos”
In Europe, vertical silos encompassing trading, 
clearing, and settlement infrastructures have been 
created, while other silos have been dismantled. The 
discussion on which structure is preferable is ongoing, 
and the answer may be different for different markets. 
While silos may help infrastructure providers to re-
duce operating costs and to better coordinate the pric-
es of the different integrated services (for example, 
trading, clearing, and settlement), they may reduce 53 Federal Reserve Bank of Chicago
competition when they are misused, for example, to 
favor a central counterparty in the silo over its com-
petitors outside of the silo. As the Eurosystem explained 
in its policy statement of September 2001, the disad-
vantages of vertical silos “can be overcome provided 
that customers can choose between systems along the 
value chain.… It is therefore crucial that access to es-
sential facilities, whether vertically integrated or not, 
should not be unfairly impeded.”
Growing need for adequate infrastructure in the 
field of credit derivatives
Volume growth in derivatives—especially over-the-
counter (OTC) derivatives—outpaces the cash markets, 
spurred on by increased interest in hedge funds and 
the ongoing innovation in the types of contract offered. 
While the interest rate contract remains the key hedge 
instrument (US$187 trillion outstanding), the credit 
default contract (US$6.3 trillion outstanding) is grow-
ing approximately 90 percent per year, now reaching 
10,000 trades per day. Volume growth is expected to 
continue over the coming years, causing some con-
cern among operations managers on the OTC market, 
given the lack of straight through processing and hence 
capacity to manage the volumes. This rapid multidi-
mensional growth (that is, in terms of products, volumes, 
market participants, and secondary markets) calls for 
an enhancement of the post-trading infrastructure that 
may support more careful risk control by the various 
participants. As mentioned by Governor Kroszner, 
enhancing the post-trading infrastructure does not au-
tomatically mean to introduce telles quelles [“just as 
they are”] the same techniques that CCPs use in ex-
changed-traded derivatives but rather to identify the 
solutions that are equally effective and take into ac-
count the different features of OTC markets.
All these developments refer to the market struc-
ture that surrounds central counterparties and are highly 
relevant for the interests of central banks in the fields 
of financial stability and financial integration. As cen-
tral banks, we believe that the market structure should 
be market driven as long as market failures are not 
observed. Significant market failures, however, must 
be identified and, in many cases, require appropriate 
public intervention. 
This brings me to my last point.
What is the role of public authorities and, in 
particular, central banks?
Market forces need a sound legal, regulatory, and 
oversight basis to work efficiently. In the euro area 
with its 12 countries, and in the European Union with 
its 25 countries, the creation of such a sound basis  
requires first and foremost a certain degree of harmo-
nization of public principles and standards across 
countries. Efforts in this direction are ongoing and  
the Eurosystem provides active support. Here I should 
mention the joint work by the European System of 
Central Banks and the Commission of European  
Securities Regulators toward establishing standards 
for securities clearing and settlement in the European 
Union. As indicated in the ECB policy statement of 
2001, standards are to be carefully set and then im-
plemented by public authorities with a clear interest 
and expertise in the respective field. It appears evident 
that the Eurosystem, for example, should be involved 
in the oversight of any major infrastructure for euro-
denominated assets with a view to being able to properly 
address serious threats to financial stability. A paper, 
authored by a professor at the Woodrow Wilson School 
at Princeton University in 1990, addressing the perfor-
mance of the derivatives clearing and settlement sys-
tems during the 1987 stock market break, concluded, 
inter alia, that “the Federal Reserve played a vital job 
in protecting the integrity of the clearing and settlement 
systems.”1 The name of that professor is Ben Bernanke.
Finally, it is important that cross-fertilization of 
experiences and expertise of market participants, aca-
demics, and public authorities in this field continues, 
and as I said before, this conference has certainly 
contributed in this respect.
1Ben S. Bernanke, 1990, “Clearing and settlement during the 
crash,” Review of Financial Studies, Vol. 3, No. 1, pp. 133–151.
NOTE

Issues related to central counterparty clearing: concluding remarks

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Issues related to central counterparty clearing: concluding remarks

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