Journal of Financial Market Infrastructures

Central counterparties need thicker skins

Vijay Albuquerque, Christopher Perkins and Mariam Rafi

  • An analytical framework for calibrating skin-in-the-game contributions is proposed.
  • This expected shortfall framework presents a starting point for a construct that establishes balance and incentivizes both CPs and clearing members to thoughtfully manage risk.


In the aftermath of the global financial crisis, clearinghouses play an increasingly important role in systemic risk management. Accordingly, central counterparty (CCP) resiliency, recovery and resolution is now moving to the forefront of regulatory focus, as the industry tackles concerns around CCPs becoming the next "too big to fail" institutions. This paper focuses on one element of CCP risk frameworks, a CCP's own contribution to the default waterfall, otherwise known as "skin in the game" (SITG). While regulation generally holds CCPs to stringent risk management standards, SITG calibration is left largely to CCPs' own discretion. CCP SITG has remained largely static and disproportionately sized relative to the risk in the system. In this paper, we propose an analytical approach to calculating CCP SITG that ensures CCPs are properly incentivized to share responsibility for socialization of risk during a default management scenario. Our dynamic, risk-based model incorporates an expected shortfall framework, with regulatory floors to control for pro-cyclicality and address concentration risk. As the industry and regulators work to formulate an appropriate calibration model for CCP SITG, this expected shortfall framework presents a reasonable starting point for a construct that establishes balance and incentivizes both CPs and clearing members to thoughtfully manage risk brought into the system.

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