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

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7.1 Centralised Clearing

In this chapter, we consider the role of central counterparties (CCPs) to provide a means for centralisation, mutualisation and reduction of counterparty risk. Following the global financial crisis that started in 2007, there has been a significant regulatory interest in expanding the role of CCPs for mitigating counterparty risk. In particular, the interest has been strong for credit derivatives products with their embedded wrong-way risks. Channelling OTC derivatives transactions through CCPs has two main objectives. The first is to reduce counterparty credit risk. The second is to increase transparency so that regulators are more easily able to quantify the positions being taken and carry out stress tests. We will discuss the function of a CCP in detail and aim to highlight the strengths, weaknesses and possible unintended consequences of a large move towards central clearing. Around a quarter of the OTC derivatives market (by notional) is already centrally cleared and this fraction is likely to increase significantly over the coming years. Clearly, a close look at the strengths and weaknesses of central clearing is relevant.

7.1.1 Systemic Risk

One of the key concerns over the global OTC derivatives market has always been systemic risk. Systemic risk does not have a firm definition but is essentially financial system instability exacerbated by distress of financial intermediaries. In the context of counterparty risk, systemic risk could arise from the ...

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