Clearinghouses and Systemic Risk
- Author(s): Paolo Saguato, Guido Ferrarini
- Posted: 12-2021
- Law & Economics #: 21-43
- Availability: Full text (most recent) on SSRN
After the 2008 financial crisis, over-the-counter derivatives markets were closely examined and determined to be a contributing factor. At the time, the four primary concerns with the derivatives markets were: (1) the limited number of interconnected market players, which raised the risk of domino defaults; (2) the lack of containment safeguards during times of market distress; (3) the absence of transparency, which hampered oversight efforts; and (4) no existing public regulatory scheme.
In response, policymakers developed and implemented a new regulatory framework intended to reduce risk-taking behavior and better contain systemic risk. This framework mandated the use of clearinghouses for all standardized derivatives as the foundation of the new system. Clearinghouses are helpful in combatting these problems because they add stability by managing risks and have an enhanced ability to absorb losses and internalize costs. As middlemen, they exert a stabilizing influence, increasing efficiency and security. In addition to the clearinghouses, standards for governance and risk management, as well as procedures for international cooperation and supervision were implemented. A decade later, there is a need to reevaluate.
This chapter examines the post-crisis clearinghouse regime and how it influences risk within the markets. It also identifies two potential points of failure in the existing regulatory scheme. First, how the universal role of clearinghouses necessarily makes any associated risk systemic as well. Second, how strained international economic relations threaten the future of collaborative cross-border supervision of the market. The chapter issues a call to action for policymakers by underscoring ongoing weaknesses in the derivatives markets system. Later, it proposes policy changes aimed at improving clearinghouse resiliency.