Journal of Financial Market Infrastructures

Who pays? Who gains? Central counterparty resource provision in the post-Pittsburgh world

Fernando Cerezetti, Jorge Cruz Lopez, Mark Manning and David Murphy

  • As the regulatory reforms since the global financial crisis have been rolled out, exposures have increased, and tension has grown between CCP owners and users. Much of this tension can be explained by a misalignment between the policy goal—financial stability—and the particular mechanism chosen to deliver on this goal—mandatory central clearing through CCPs as they are currently organized;
  • The design of CCPs and, in particular, their model for resource provision, makes them suitable for managing club goods, where access can be excluded to non-paying market participants.  Financial stability, on the other hand, is a public good, which allows all market participants to benefit from it.  The key differences between these two types of goods, driven by the wedge between those who pay for them and those who derive the benefits, creates the observed tension;
  • The paper develops a conceptual framework to examine whether the regulatory changes since the Pittsburgh Summit could be a catalyst for reconsidering the structure of clearing houses.  After analysing the operational elements of a CCP, the paper concludes that it might be effective to unbundle the functions of a CCP, selecting the ownership and funding structure that best suits their individual characteristics;
  • In particular it may be possible to isolate the functions that are truly critical to the provision of the public good—multilateral netting of novated trades, custody of margin and reinvestment of cash collateral—and establish an explicit public backstop for these, while allowing other functions to be provided under models with either a private or a club orientation.

At the Pittsburgh Summit in 2009, G20 leaders agreed to wide-reaching reforms to over-the-counter (OTC) derivatives markets. One of these reforms required the clearing of standardized OTC derivatives through central counterparties (CCPs). Since then, CCPs have become increasingly important. There has been an extensive programme of regulatory change affecting CCPs, OTC derivatives markets and their participants. As OTC clearing has grown, tension has increased between different classes of market participants over the traditional CCP model of resource provision through loss mutualization. We argue that most of this tension can be explained by a misalignment between the policy goal of enhancing financial stability and the delivery of that goal by mandating clearing through CCPs as they are currently organized. Specifically, the traditional model for resource provision makes most CCPs suitable for managing “club goods”, whereas financial stability is a “public good”. The key differences between these two types of goods, driven by the wedge between those who pay for them and those who derive the benefits, create the observed tensions. Based on this analysis, we propose a framework to analyze the functional elements of a CCP and examine whether an alternative clearing model might be more effective. We conclude that incentives would be better aligned if the functions of CCPs were unbundled and the ownership and funding structures that best suit their individual characteristics were selected. Functions that are critical for the provision of financial stability might suggest some form of public sector involvement, whereas other services might lend themselves to a for-profit or traditional club model.

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