CCPs: Their Risks, and How They Can Be Reduced

Abstract

One key feature of the Dodd—Frank Act is the requirement that the majority of derivatives contracts should be cleared through central counterparties (CCPs). This feature will substantially increase transparency and decrease exposure to counterparty credit risk in the over-the-counter (OTC) derivatives business, both of which are highly desirable from the point of view of the trading public. But a number of other issues are raised in the process, including the effect of counterparty risk vis-à-vis the clearinghouse, as Hull elaborates. He then suggests an alternative procedure for unwinding the positions of a defaulting clearing member, which would reduce the exposure of the clearinghouse itself to the risk of insolvency following a major member default.

TOPICS: Derivatives, counterparty risk, exchanges/markets/clearinghouses