Journal of Financial Market Infrastructures

Risk.net

Too much, too young: improving the client clearing mandate

David Murphy

  • The policy of mandatory clearing of standardized OTC derivatives applies to both clearing members and clients, and has had a major impact on OTC derivatives markets.
  • Aspects of the mandate are under review, so now is a good time to consider potential revisions to it.
  • The definition of the mandate should be based on parties contribution to systemic risk, with only those whose trades contribute meaningfully to it being forced to clear.
  • Data suggests that there are a small number of large and sometimes concentrated clients. Most or all of these clients should clear, but in a way which does not introduce unnecessary extra risk to them, their clearing members or CCPs.

The policy of clearing standardized over-the-counter (OTC) derivatives contracts through central counterparties (CCPs) was introduced after the 2008 crisis, and it has had a major impact. It has been implemented in major jurisdictions via “clearing mandates” that apply to the clearing members of CCPs and their clients. Since the policy was implemented, OTC derivatives markets have changed in ways that reduce the benefit of central clearing for clients. As policy makers are currently reviewing clearing mandates, considering how to improve them is apposite. Against this background, we present new evidence of the distribution of risk in client portfolios and use this to motivate clearing policy improvements. We recommend that the mandate to clear should be phrased in terms of initial margin. We present evidence of the concentration in client clearing service provision and suggest that regulatory barriers to increased competition should be lifted. Finally, we discuss two innovations that would increase the likelihood of clients moving between clearing members. This process, known as porting, is an important potential benefit of clearing. These innovations are the creation of a special-purpose clearing member for porting, and the development of access models for larger clients that will reduce their dependence on clearing members.

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