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We propose a model for the credit and liquidity risks faced by clearing members of Central Counterparty Clearing houses (CCPs). This model aims to capture the features of: gap risk; feedback between clearing member default, market volatility and margining requirements; the different risks faced by various types of market participant and the changes in margining requirements a clearing member faces as the system evolv…
The introduction of CCPs in most derivative transactions will dramatically change the landscape of derivatives pricing, hedging and risk management, and, according to the TABB group, will lead to an overall liquidity impact about 2 USD trillions. In this article we develop for the first time a comprehensive approach for pricing under CCP clearing, including variation and initial margins, gap credit risk and collatera…
We present a dialogue on Funding Costs and Counterparty Credit Risk modeling, inclusive of collateral, wrong way risk, gap risk and possible Central Clearing implementation through CCPs. This framework is important following the fact that derivatives valuation and risk analysis has moved from exotic derivatives managed on simple single asset classes to simple derivatives embedding the new or previously neglected type…
The market practice of extrapolating different term structures from different instruments lacks a rigorous justification in terms of cash flows structure and market observables. In this paper, we integrate our previous consistent theory for pricing under credit, collateral and funding risks into term structure modelling, integrating the origination of different term structures with such effects. Under a number of ass…
We study two questions related to competition on the OTC CDS market using data collected as part of the EMIR regulation. First, we study the competition between central counterparties through collateral requirements. We present models that successfully estimate the initial margin requirements. However, our estimations are not precise enough to use them as input to a predictive model for CCP choice by counterparties i…
Current post-trade clearing systems rely almost exclusively on cash or cash-like collateral, leaving vast reserves of short-term liquidity embedded in trade credit outside formal settlement infrastructures. A key barrier to integrating this liquidity is the near-universal dependence of clearing services on novation, which imposes institutional overhead that restricts accessibility and limits the range of obligations …
An uncollateralized swap hedged back-to-back by a CCP swap is used to introduce FVA. The open IR01 of FVA, however, is a sure sign of risk not being fully hedged, a theoretical no-arbitrage pricing concern, and a bait to lure market risk capital, a practical business concern. By dynamically trading the CCP swap, with the liability-side counterparty provides counterparty exposure hedge and swap funding, we find that t…
We develop an arbitrage-free framework for consistent valuation of derivative trades with collateralization, counterparty credit gap risk, and funding costs, following the approach first proposed by Pallavicini and co-authors in 2011. Based on the risk-neutral pricing principle, we derive a general pricing equation where Credit, Debit, Liquidity and Funding Valuation Adjustments (CVA, DVA, LVA and FVA) are introduced…
For vanilla derivatives that constitute the bulk of investment banks' hedging portfolios, central clearing through central counterparties (CCPs) has become hegemonic. A key mandate of a CCP is to provide an efficient and proper clearing member default resolution procedure. When a clearing member defaults, the CCP can hedge and auction or liquidate its positions. The counterparty credit risk cost of auctioning has bee…
Central clearing counterparty houses (CCPs) play a fundamental role in mitigating the counterparty risk for exchange traded options. CCPs cover for possible losses during the liquidation of a defaulting member's portfolio by collecting initial margins from their members. In this article we analyze the current state of the art in the industry for computing initial margins for options, whose core component is generally…
We analyze the systemic risk for disjoint and overlapping groups (e.g., central clearing counterparties (CCP)) by proposing new models with realistic game features. Specifically, we generalize the systemic risk measure proposed in [F. Biagini, J.-P. Fouque, M. Frittelli, and T. Meyer-Brandis, Finance and Stochastics, 24(2020), 513--564] by allowing individual banks to choose their preferred groups instead of being as…
The Pakistan competition policy, as in many other countries, was originally designed to regulate business conduct in traditional markets and for tangible goods and services. However, the development and proliferation of the internet has led to the emergence of digital companies which have disrupted many sectors of the economy. These platforms provide digital infrastructure for a range of services including search eng…
We introduce a dynamic model of the default waterfall of derivatives CCPs and propose a risk sensitive method for sizing the initial margin (IM), and the default fund (DF) and its allocation among clearing members. Using a Markovian structure model of joint credit migrations, our evaluation of DF takes into account the joint credit quality of clearing members as they evolve over time. Another important aspect of the …
This paper develops an XVA (costs) analysis of centrally cleared trading, parallel to the one that has been developed in the last years for bilateral transactions. We introduce a dynamic framework that incorporates the sequence of cash-flows involved in the waterfall of resources of a clearing house. The total cost of the clearance framework for a clearing member, called CCVA for central clearing valuation adjustment…
We study the impact of central clearing of over-the-counter (OTC) transactions on counterparty exposures in a market with OTC transactions across several asset classes with heterogeneous characteristics. The impact of introducing a central counterparty (CCP) on expected interdealer exposure is determined by the tradeoff between multilateral netting across dealers on one hand and bilateral netting across asset classes…
A clearing member of a Central Counterparty (CCP) is exposed to losses on their default fund and initial margin contributions. Such losses can be incurred whenever the CCP has insufficient funds to unwind the portfolio of a defaulting clearing member. This does not necessarily require the default of the CCP itself. In this note we aim to quantify the risk a financial institution has when facing a CCP. We show that a …
Central Counterparties (CCPs) are widely promoted as a requirement for safe banking with little dissent except on technical grounds (such as proliferation of CCPs). Whilst CCPs can have major operational positives, we argue that CCPs have many of the business characteristics of Rating Agencies, and face similar business pressures. Thus we see a risk that prices from CCPs may develop the characteristics attributed to …
We introduce an innovative theoretical framework to model derivative transactions between defaultable entities based on the principle of arbitrage freedom. Our framework extends the traditional formulations based on Credit and Debit Valuation Adjustments (CVA and DVA). Depending on how the default contingency is accounted for, we list a total of ten different structuring styles. These include bipartite structures bet…
Counterparty Risk (Systems).
Central Clearing (Systems).
Clearing Member Default Waterfall — Loss-allocation sequence after a clearing member fails.
Variation Margin Call — Daily mark-to-market cash calls that can drain liquidity.
CCP Liquidity Drain US (Liquidity).
CCP Liquidity Drain Euro Area (Liquidity).
CCP Liquidity Drain UK (Liquidity).
CCP Liquidity Drain Japan (Liquidity).
CCP Liquidity Drain China (Liquidity).
CCP Liquidity Drain EM Asia (Liquidity).
CCP Liquidity Drain LatAm (Liquidity).
CCP Liquidity Drain CEEMEA (Liquidity).
CCP Liquidity Drain Canada (Liquidity).
CCP Liquidity Drain Australia (Liquidity).
CCP Liquidity Drain risk-on (Liquidity).
CCP Liquidity Drain risk-off (Liquidity).
CCP Liquidity Drain tightening (Liquidity).
CCP Liquidity Drain easing (Liquidity).
CCP Liquidity Drain stagflation (Liquidity).
CCP Liquidity Drain reflation (Liquidity).
CCP Liquidity Drain disinflation (Liquidity).
CCP Liquidity Drain liquidity-crisis (Liquidity).
CCP Liquidity Drain carry (Liquidity).
CCP Liquidity Drain recession (Liquidity).
CCP Liquidity Drain month-end (Liquidity).
CCP Liquidity Drain quarter-end (Liquidity).
CCP Liquidity Drain year-end (Liquidity).
CCP Liquidity Drain Australia (Liquidity).
CCP Liquidity Drain Canada (Liquidity).
CCP Liquidity Drain carry (Liquidity).
CCP Liquidity Drain CEEMEA (Liquidity).
CCP Liquidity Drain China (Liquidity).
CCP Liquidity Drain disinflation (Liquidity).
CCP Liquidity Drain easing (Liquidity).
CCP Liquidity Drain EM Asia (Liquidity).
CCP Liquidity Drain Euro Area (Liquidity).
CCP Liquidity Drain Japan (Liquidity).
CCP Liquidity Drain LatAm (Liquidity).
CCP Liquidity Drain liquidity-crisis (Liquidity).
CCP Liquidity Drain month-end (Liquidity).
CCP Liquidity Drain quarter-end (Liquidity).
CCP Liquidity Drain recession (Liquidity).
CCP Liquidity Drain reflation (Liquidity).
CCP Liquidity Drain risk-off (Liquidity).
CCP Liquidity Drain risk-on (Liquidity).
CCP Liquidity Drain stagflation (Liquidity).
CCP Liquidity Drain tightening (Liquidity).
CCP Liquidity Drain UK (Liquidity).
CCP Liquidity Drain US (Liquidity).
CCP Liquidity Drain year-end (Liquidity).