Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

7.4 Conclusions

Bilateral OTC markets have been extremely successful and their growth has been greater than that of exchange-traded products over the last 15 years. Whilst it seems obvious that a bilaterally cleared market is more vulnerable to systemic risk, this is not an argument for the naïve introduction of CCPs. CCPs reallocate counterparty risk, but they do not make it disappear. This can be beneficial – for example, a corporate hedging their balance sheet may be wiped out if a major dealer defaults. In a CCP world, this risk is potentially reallocated to market participants who can bear it more reasonably (at a cost, of course).

CCPs reduce systemic risk (e.g., mitigating the impact of clearing member failure) and increase it (e.g., by increasing margins during a period of stress where firms may have to liquidate assets to meet large margin calls which in turn may exacerbate price volatility). Hence, CCPs transform systemic risk but do not definitely reduce it overall.

The question as to whether CCPs really reduce counterparty and/or systemic risk overall should be carefully considered. In bilateral markets, dealers compete for business partially based on their ability to manage counterparty risk. A CCP takes away the incentive to properly price and manage the counterparty risk created when entering a trade. Regulation may favour a certain CCP and this will create sub-optimal outcomes and market instability. A CCP would, of course, have its own risk management capabilities ...