ESRB published a working paper presenting a network analysis of the centrally cleared interest rate derivatives market in the EU, by looking at counterparty relations in both direct (house) clearing and client clearing.
Since the majority of the gross notional is transferred within central counterparties (CCPs) and their clearing members, client clearing is often neglected in the literature, despite its significance in terms of net exposures. The authors find that the client clearing structure is very strongly interconnected and contains on the order of 90% of the counterparty relations in the interest rate derivatives market. Moreover, it is more diverse in terms of geography and sectors of the financial market that the counterparties are associated with. Client clearing is also significantly more volatile in time than direct clearing. These findings underline the importance of analyzing the structure and stability of both direct and client clearing of the interest rate derivatives market in Europe, to improve understanding of this important market and potential contagion mechanisms within it.
The results hint that G16 dealers play a crucial role in the centrally cleared interest rate derivatives market. This means that, for macro-prudential reasons, there is a need to consider the interplay between banking and financial market infrastructures, which is not trivial, not least due to the difference in business models between the two. Future research should look into the structure of centrally cleared market for other classes of derivative contracts, most notably foreign exchange derivatives and the credit default swap (CDS) market, taking into account client clearing as in this study.
Related Link: Working Paper (PDF)
Keywords: Europe, EU, Securities, CCPs, Interest Rate Derivatives, Central Clearing, ESRB
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