Central clearing significantly reduces systemic risk and their amplifying factors in financial markets, according to a white paper by Eurex Clearing, the central counterparty (CCP) of Deutsche Börse Group.
The paper, “How central counterparties strengthen the safety and integrity of financial markets”, says the regulatory agenda to broaden the use of CCP clearing together with high regulatory requirements makes financial markets more robust and transparent and benefits the wider economy.
In particular central clearing reduces risks in bilaterally negotiated products such as OTC derivatives and allows to mitigate systemic risks in these markets.
“The white paper shows the macro-prudential advantage of a centrally cleared market versus a bilateral one,” says Thomas Book, CEO of Eurex Clearing. “CCPs demonstrated their resilience and benefits during the recent crisis. As the new regulatory regime takes shape the positive features of cleared markets will be further strengthened. Of great importance are the recovery and resolution frameworks which ensure that systemic events can be managed appropriately.”
The white paper first analyses the functioning of a CCP and the effect central clearing has on systemic risk mitigation in financial markets. As independent risk managers between market participants, CCPs ensure prudent collateralisation and have procedures to manage defaults in an orderly manner.
The second part of the paper outlines the necessary standards and features that need to be met when operating a CCP. An analysis of past disruptions of CCPs against regulatory requirements shows that EMIR, the European post-trade regulation, already sets highest standards and can serve as a regulatory benchmark globally.
The final part of the paper discusses the ways in which the CCP mechanism permits markets to recover – or be wound down – if unprecedented market shocks overwhelm the existing safeguards without disrupting the entire financial markets. While existing regulation already strengthens the CCP construct, the added safety of specific recovery and resolution frameworks for financial market infrastructures enable the CCP stakeholders to act decisively to resolve such market shocks and exclude public bail-outs. Consequently, CCPs mitigate systemic risk and strengthen the robustness of financial markets.