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

7.3 Analysis of the Impact and Benefits of CCPs

In the description of the mechanics of CCP trading, advantages and disadvantages emerge. We have also described the creation of effects such as moral hazard and adverse selection. These are not insurmountable disadvantages (after all, the insurance market operates despite such problems), but may lead to unintended consequences. We now look at the strengths and weaknesses of CCPs in more detail.

7.3.1 The Advantage of Centralised Clearing

The advantages of trading through a CCP are:

• Multilateral netting. Contracts traded between different counterparties but traded through a CCP can be netted. This increases the flexibility to enter new transactions and terminate existing ones and reduces margin costs. Trading out of positions through a CCP is easy and, unlike bilateral markets, can be done with any other counterparty where the multilateral netting benefit is provided by the CCP. Furthermore, reducing the total positions that need to be replaced in the event of a default reduces price impact.
• Loss mutualisation. Even when a default creates losses that exceed the financial commitments from the defaulting member, these losses are distributed throughout the CCP members, reducing their impact on any one member. Thus, a counterparty's losses are dispersed partially throughout the market, making their impact less dramatic and reducing the possibility of systemic problems.
• Legal and operational efficiency. The margining, netting and settlement ...