A systemic risk assessment of OTC derivatives reforms and skin‐in‐the‐game for CCPs

Abstract

The G20 OTC (over-the-counter) derivatives reforms impose large collateral/liquidity demands on clearing members of Central Counterparty (CCP) clearing platforms in the form of initial margins, variation margins and contributions to the default fund. In Heath et al. (2016), it was shown how this introduces a trade-off between liquidity risk and solvency risk with the system manifesting considerable systemic risk from these two sources of risk while CCP penetration is at current levels. The authors extend this analysis to include the European Market Infrastructure Regulation (EMIR) skin-in-the-game requirements for CCPs, which aim to ameliorate the contributions to the default fund by clearing members and also to prevent moral hazard problems associated with the too-interconnected-to-fail (TITF) status of CCPs as more and more derivatives are centrally cleared. The authors provide a systemic risk assessment of these features of the OTC derivatives reforms using network analysis based on 2015-end data on the derivatives positions for 40 globally systemically important banks (G-SIBs).