Journal of Financial Market Infrastructures

Risk.net

Skin in the game

Dennis McLaughlin

This paper analyses the cost of increasing the level of Skin In The Game (SITG) for a CCP and demonstrates the following:

  • Under the powers granted to a CCP by its Rulebook, the need for CCP Capital is primarily driven by the Non Default Loss exposure profile.
  • The potential to increase SITG from current levels is limited both by the cost of equity in the clearing sector and the return on capital for the particular CCP.
  • A substantial increase in SITG over current levels would require a corresponding substantial increase in clearing fees across the financial sector.  

This paper analyzes the cost of putting  aside capital as skin in the game (SITG). It shows first that under the powers granted to a central counterparty (CCP) by its rule-book, the need for CCP capital is primarily driven by the nondefault loss exposure profile, and not necessarily by the quantum of cleared positions. Further, it demonstrates that there is only limited potential to increase the SITG at a CCP, given that it is a private institution  that must return the equity cost of capital to the market to continue in business. In practice, this restricts the ability to mandate higher SITG for CCPs, for if no private  sector CCP can meet the cost of equity capital, then the clearing solution  needs to be provided by the taxpayer, which is an unacceptable outcome. Finally, this paper calculates the trade-off between increasing SITG and increasing clearing costs to members, to compensate the CCP for returns falling below the equity cost of capital. It establishes that a substantial  increase in SITG over current levels would require  a corresponding  substantial  increase in clearing fees across the financial  sector.

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: